-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RPzxZUqXMilHxIBcZsx9pCwSbMsaUIM4L9woIfnaLiuCHa8EldDmgvyrFg66SOdV fkcbw5LerAyM9XPm9dadsQ== 0000891618-98-005517.txt : 19981231 0000891618-98-005517.hdr.sgml : 19981231 ACCESSION NUMBER: 0000891618-98-005517 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981230 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SILICON VALLEY GROUP INC CENTRAL INDEX KEY: 0000712752 STANDARD INDUSTRIAL CLASSIFICATION: SPECIAL INDUSTRY MACHINERY, NEC [3559] IRS NUMBER: 942264681 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-11348 FILM NUMBER: 98777682 BUSINESS ADDRESS: STREET 1: 101 METRO DRIVE STREET 2: SUITE 400 CITY: SAN JOSE STATE: CA ZIP: 95110 BUSINESS PHONE: 4084416700 MAIL ADDRESS: STREET 1: 101 METRO DRIVE STREET 2: SUITE 400 CITY: SAN JOSE STATE: CA ZIP: 95110 10-K 1 FORM 10-K FOR FISCAL YEAR ENDED 9/30/98 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998* [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER: 0-11348 SILICON VALLEY GROUP, INC. [SVG LOGO](EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-2264681 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
101 METRO DRIVE, SUITE 400, SAN JOSE, CALIFORNIA 95110 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 441-6700 SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01 PAR VALUE Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by persons other than those who may be deemed affiliates of the Registrant, as of November 27, 1998, was approximately $301,562,808. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may under certain circumstances be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the Registrant's Common Stock as of November 27, 1998 was 32,816,577. * See Part II, Item 8 of this report for information regarding Registrant's fiscal year. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference into the parts of this Form 10-K as indicated herein: Proxy Statement for Annual Meeting of Stockholders to be held on February 23, 1999......................................... Part III Annual Report to Stockholders for fiscal year ended September 30, 1998........................................ Parts II & IV
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I The information in this report 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, as amended. Such statements are subject to certain risks and uncertainties, including those discussed below and set out in the Annual Report incorporated by reference herein, that could cause actual results to differ materially from those described herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Forward-looking statements are indicated by an asterisk (*) following the sentence in which such statement is made. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. ITEM 1. BUSINESS. Silicon Valley Group, Inc. (the "Company" or "SVG") designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits. The fabrication of integrated circuits involves repeating a complex series of process steps to a semiconductor wafer. The three broad categories of wafer processing steps are deposition, photolithography and etching. SVG has three principal product groups which focus primarily on photolithography, photoresist processing, and deposition for oxidation/diffusion and low-pressure chemical vapor deposition ("LPCVD"). In addition, a precision optics group supplies certain components for the Company's photolithography products, government markets and lens systems to the cinematography industry. The Company's products incorporate proprietary technologies and unique processes, and focus on providing process and product technologies and productivity enhancements to its customers. SVG works closely with its existing and potential customers in the development of new systems and technologies and supports its products through a network of worldwide service and technical support organizations. Herein the Company refers to its photolithography exposure products as SVG Lithography Systems, Inc. "SVGL" products, its photoresist processing products as "Track" products and its oxidation/diffusion and LPCVD products as "Thermco" products. INDUSTRY BACKGROUND Continuous improvements in semiconductor process and design technologies have led to the production of smaller, more complex and more reliable semiconductor devices at a lower cost per function. As performance has increased and size and cost have decreased, the demand for semiconductors has expanded in computer systems, telecommunications systems, automotive products, consumer goods and industrial automation and control systems. Semiconductor content as a percentage of system cost has also increased. The Company believes that these long-term trends will continue and will be accompanied by a growing demand for semiconductor production equipment that can produce advanced integrated circuits in high volumes with a low cost of ownership.* The rapid development of advanced semiconductor applications requires semiconductor manufacturers to continually improve their core technology and manufacturing capabilities to remain competitive within the industry. As a consequence, semiconductor manufacturers demand increasingly sophisticated, cost effective processing equipment from semiconductor equipment suppliers. The increasing diversity and complexity of semiconductor products, the demands of technological change and the costs associated with keeping pace with industry developments have contributed to the emergence of cooperative development and manufacturing alliances both between semiconductor manufacturers and between semiconductor manufacturers and semiconductor equipment suppliers. The Company believes it is essential to have customer alliances to provide access to valuable product and process technologies. These factors result in customers concentrating their business with a small number of key suppliers. The semiconductor industry into which the Company sells its products is highly cyclical and historically experienced periodic downturns that have had a severe effect on the semiconductor industry's demand for semiconductor processing equipment. As a result of the Asian economic crisis, an oversupply of 1 3 certain semiconductor products, the impact of low cost personal computers, and various other factors, semiconductor manufacturers have reduced planned expenditures and cancelled or delayed the construction of new fabrication facilities. This slowdown in demand began to impact the Company during the fourth quarter of calendar 1997 (the Company's first fiscal quarter of 1998) as the Company experienced lower customer bookings, customer deferrals of scheduled equipment delivery dates and, to a lesser extent, customer order cancellations which continued through the third calendar quarter of 1998 (the Company's fourth fiscal quarter of 1998). These events have caused the Company to significantly reduce its work force, consolidate and combine certain functions and redirect product lines which necessitated a fourth quarter 1998 pretax restructuring charge of $33,680,000. As a result of the lower bookings, order rescheduling and cancellations, the Company believes sales during the first half of fiscal 1999 will be lower than sales during the second half of fiscal 1998.* There can be no assurance that the Company will not experience further customer delivery deferrals, additional order cancellations or a prolonged period of customer orders at reduced levels, any or a combination of which would have a material adverse effect on the Company's business and results of operations.* STRATEGY The Company's objective is to strengthen its position as a leading worldwide semiconductor equipment supplier that offers a broad line of technologically advanced products. The Company's strategy incorporates the following key elements: - Technological Innovation. The Company is committed to developing new products, improving processes and enhancing existing products through substantial investment in research and development. The Company designs and manufactures sophisticated semiconductor manufacturing systems for advanced fabrication facilities. Its products incorporate proprietary technologies in photolithography, control software, optics and particulate control and unique processes focusing on providing process and product technologies and productivity enhancements to customers. Additionally, the Company works with universities and laboratories to leverage new concepts for its advanced projects. - Customer Collaboration. The Company's objective is to strengthen its position as a leading worldwide semiconductor equipment supplier by offering a broad line of technologically advanced products. The Company works closely with its existing and potential customers, industry consortia and research institutions to improve current products and processes and to define new product development opportunities. These efforts enable the Company to participate in the development of new technologies, to influence the design of new fabrication processes and to position itself as a principal supplier for volume equipment orders. The Company believes that cooperative working relationships with leading semiconductor manufacturers are critical to ensuring that its products are designed in conjunction with the development of the semiconductor manufacturers' advanced process requirements. - Continuous Improvement. The industry requires that equipment suppliers provide cost effective products that are based on extendible technology. Cost of ownership and the ability to satisfy customer delivery requirements are critical ingredients in the selection process for advanced equipment. To address these issues, the Company is responding by expanding certain of its facilities and deploying capital for manufacturing and test equipment to respond to the long term requirements of the semiconductor industry. The Company continues to implement programs to increase the effectiveness of its material procurement, reduce manufacturing cycle times and improve production methods and processes to gain additional efficiencies. - Expanding Worldwide Customer Service and Support. The Company's customers are concentrating their business with a smaller number of key suppliers and demanding higher levels of support and service from these suppliers as the semiconductor fabrication process becomes increasingly complex. The Company has responded to this trend by making substantial investments in its global service and support capabilities. 2 4 SVG LITHOGRAPHY SYSTEMS, INC. (SVGL) SVGL designs, manufactures, markets and services advanced photolithography exposure systems. Photolithography is one of the most critical and expensive steps in integrated circuit fabrication, representing approximately one-third or more of the fabrication cost. Consequently, integrated circuit manufacturers focus on obtaining advanced photolithography equipment to help them produce critical layers for increasingly complex devices reliably, efficiently and cost-effectively. In the photolithography step of the fabrication process, the integrated circuit patterns are projected through masks, or reticles, onto the silicon wafers. As semiconductors have become more complex, the patterns have become finer, with line widths as narrow as 0.25 micron (approximately 10 millionths of an inch) and below in many of today's more advanced integrated circuits. As the patterns become finer, photolithography exposure systems must be capable of projecting the patterns through the masks with ever finer resolution. The resolution capability of a photolithography exposure system is a function of numerical aperture (a measure of its light gathering characteristics) and the wavelength of the light used in exposure. With the advancement of photolithography technology has come a trend toward the reduction in wavelength from G-line (436 nanometer) to I-line (365 nanometer) to DUV (248 and 193 nanometer) and the increase in numerical aperture from 0.2 to approximately 0.7. Additionally, efforts are commencing to investigate, and in some instances develop 157 nanometer and post-optical technology to advance product line widths as fine as .07 microns. Historically, there have been two major approaches to photolithography exposure systems: full field scanning projection aligners ("scanners") and refractive steppers ("steppers"). Scanners project a full scale mask image onto a moving full wafer, while steppers sequentially expose a small section of a wafer in a stepped sequence of exposures, but do so by reducing the size of a mask image by several fold (typically 5 times). Thus, scanners offer large exposure fields while steppers offer masks that are easier to make and have a lower cost. These strengths are combined in the step-and-scan system, a technology pioneered by SVGL. Micrascan. The Company believes that its Micrascan photolithography step-and-scan exposure system provides the increased resolution required for current advanced logic and memory devices and for succeeding generations of complex, fine geometry integrated circuits through its use of DUV lamp or laser light source and unique projection optics design. Micrascan overcomes the line width limitations of steppers over a large exposure field by combining the elements of both steppers and scanners into the Micrascan's step-and-scan technology.* The Micrascan combines advantages of scanning projection aligners and steppers by scanning a portion of the wafer, then "stepping" to another portion of the wafer and repeating the process as necessary. Each scan has the capability to expose a large segment of the wafer. The large exposure field enables Micrascan to fabricate larger devices in a single scan than steppers, thus avoiding the necessity of "stitching" a circuit together through two different exposures, and depending on the size of the chip provides the ability to expose more than one device in an exposure field. In addition, Micrascan continuously modifies the position of the wafer surface during the scan, using its on-the-fly focus system to keep the wafer in the optimal focal plane, thus providing a larger usable depth of focus. The larger the usable depth of focus field is, the more tolerant of variations in the wafer surface the equipment will be. The Company believes Micrascan's greater tolerance of wafer surface variations can reduce the number of defective devices on a wafer, thereby contributing to higher yields.* It further believes that scanning across the field instead of exposing the entire field at one time also enables Micrascan to achieve greater uniformity of resolution across the entire exposure field and contributes to higher yields of faster devices.* The Company believes that SVGL has substantial technological expertise and process knowledge in developing deep ultraviolet ("DUV") step-and-scan photolithography systems. SVGL has developed internal capability to design and fabricate optical lenses, mirrors and coatings. This includes a combination of purchased and proprietary optical metrology using phase measuring interferometry to precisely measure and test the optical elements it produces. Micrascan incorporates both mirrors and lenses in its optical system, which the Company believes allows for an optical projection system that is less sensitive to environmental 3 5 variants and accommodates the use of light sources with broader spectral bandwidth (than refractive optics), with the additional benefits of reduced running cost and increased reliability.* In addition to the optical system technology described above, SVGL has developed certain proprietary mechanical systems incorporated in the Micrascan to control the position of the wafer and the reticules prior to and during the wafer exposure step. The Company believes that these servo controlled systems contribute to the Micrascan's ability to scan the exposure field at high speeds with no substantial loss of resolution, thereby increasing the throughput capability of the machine.* The Company believes that the photolithography exposure equipment market is one of the largest segments of the semiconductor processing equipment industry and that SVGL's Micrascan family of photolithography systems are currently the most technically advanced step-and-scan machines shipping in multiple quantities to global semiconductor manufacturers.* Micrascan II+ systems capable of printing .30 micron line widths sell for up to approximately $5,300,000, depending upon configuration. The Micrascan QML lamp-based systems and Micrascan III laser-based systems, each capable of printing .25 micron line widths, sell for up to approximately $7,200,000, depending upon configuration. Micrascan III+ capable of producing line widths of .15 micron sell for approximately $8,300,000. Although the Company specifies that its systems to produce certain line widths, it is commonplace that the combination of the tool's robustness and the customer's process technology achieves finer line widths than those specified. Uncertain Market for Micrascan Products. To address the market for advanced photolithography exposure systems, the Company has invested and expects to continue to invest substantial resources in SVGL's Micrascan technology and its family of Micrascan DUV step-and-scan photolithography systems, capable of producing line widths of .18 micron and below. The development of a market for the Company's Micrascan step-and-scan photolithography products will be highly dependent on the continued trend towards finer line widths in integrated circuits and the ability of other lithography manufacturers to keep pace with this trend through either enhanced technologies or improved processes. The Company believes DUV lithography will be required to fabricate devices with line widths below 0.3 micron.* Semiconductor manufacturers can purchase DUV steppers to produce product at .25 micron line widths. However, the Company believes that as devices increase in complexity and size and require finer line widths, the technical advantages of DUV step-and-scan systems, as compared to DUV steppers, will enable semiconductor manufacturers to achieve finer line widths with improved critical dimension control which will result in higher yields of faster devices.* The Company also believes that the transition to DUV step-and-scan systems will accelerate in calendar 1999 and that advanced semiconductor manufacturers are beginning to require volume quantities of production equipment as advanced as the current and pending versions of Micrascan to produce both critical and to some degree sub-critical layers of semiconductor devices.* Currently, competitive DUV step-and-scan equipment capable of producing .25 micron line widths is available in limited quantities from two competitors, and the Company believes that at least one other manufacturer of advanced photolithography systems will begin limited shipments of step-and-scan machines in the near future.* There can be no assurance that the Company will be successful in competing with such systems.* Further, if manufacturers of DUV steppers are able to further enhance existing technology to achieve finer line widths sufficiently to erode the competitive and technological advantages of DUV step-and-scan systems, or other manufacturers of step-and-scan systems are successful in supplying sufficient quantities of product in a timely manner that are technically equal to or better than the Micrascan, demand for the Micrascan technology may not develop as the Company expects.* The Company believes that advanced logic devices and DRAMs will require increasingly finer line widths.* Consequently, SVGL must continue to develop advanced technology equipment capable of meeting its customers' current and future requirements while offering those customers a progressively lower cost of ownership.* In particular, the Company believes that it must continue its development of future systems capable of printing line widths finer than .18 micron and processing 300mm wafers.* Any failure by the Company to develop the advanced technology required by its customers at progressively lower costs of ownership could have a material adverse impact on the Company's financial condition and results of operations.* 4 6 The Company believes that for SVGL to succeed in the long term, it must sell its Micrascan products on a global basis. The Japanese and Pacific Rim markets (including fabrication plants located in other parts of the world which are operated by Japanese and Pacific Rim semiconductor manufacturers) represent a substantial portion of the overall market for photolithography exposure equipment. To date, the Company has not been successful penetrating either of these markets. (See "Importance of the Japanese and Pacific Rim Markets.") Micralign. SVGL also sells a family of scanning projection aligners known as "Micralign." The most advanced product in this family, the Micralign 700, is used primarily in the production of semiconductor devices with minimum feature sizes above 1.25 microns, or in the fabrication of less critical layers within more sophisticated semiconductor devices. Micralign products are a mature product family and sales of Micralign products have declined in recent years as steppers have supplanted scanning projection aligners. The Company anticipates that such sales will continue to decline.* A large installed base of Micralign systems exists throughout the world and a majority of SVGL's Micralign related revenues is derived from servicing that installed base and the sales of spare parts. The list price of the Micralign 700 is approximately $1,350,000. TRACK SYSTEMS (TRACK) Track designs, manufactures, markets and services photoresist processing equipment which performs all the steps necessary to process semiconductor wafers prior to photolithography exposure, including cleaning, adhesion promotion and photoresist coating, and which performs all the steps required to treat wafers after photolithography exposure prior to etching, including developing and baking. As photoresist processing technology has evolved, the Company has developed increasingly advanced products for this market, which are capable of handling integrated circuits with line widths as narrow as 0.18 micron. Each product line includes the principal processing capabilities described above and is generally sold in customer-specified configurations that can include specially engineered features and capabilities. All Track products are available in fully automated cassette-to-cassette configurations either as stand-alone processing stations or as in-line integrated manufacturing systems. The equipment is modular in design to allow configuration to customer requirements. Each semiconductor manufacturer may require certain of the processing stations to effect its proprietary or specialized processes. As a result of being able to supply its customers with both SVGL's Micrascan photolithography systems and Track's photoresist processing products, the Company believes it offers the only clustered solution manufactured by a single supplier. Additionally, Track's 90 Series is designed to interface with all other lithography exposure products, regardless of manufacture. Track's product lines correspond to the development of successive generations of wafer processing technologies. In general, it has been the Company's experience that introduction of new Track products has been followed by lower order levels for older products. 90 Series. The 90 Series, the 90-S and the 90-SE photoresist processing systems are designed for use in fabrication processes for integrated circuits with line widths as narrow as 0.25 micron, such as is required for 64 megabit DRAMs. The 90 Series incorporates a proprietary wafer transfer system to increase throughput and provides features allowing it to interface with factory automation systems, such as those using automated guided vehicles. The 90 Series can process wafers up to eight inches in diameter. The 90-S and the more recent 90-SE offer improved cost of ownership through increased productivity and a smaller floor space requirement. Prices of the 90 Series range from approximately $650,000 to $1,700,000. 8800 Series. The 8800 Series is designed to meet market needs for photoresist contamination control and photoresist processing down to 0.8 micron line widths. The 8800 Series incorporates such automation features as beltless wafer handling, compatibility with low contamination wafer storage and movement techniques, advanced software and communications capabilities and certain process control improvements. The 8800 Series can process wafers from three to six inches in diameter. The 8800 series is a mature product and sales have declined in recent years. The Company anticipates that such sales will continue to decline.* Prices of the 8800 Series range from approximately $200,000 to $550,000. 5 7 THERMCO SYSTEMS (THERMCO) Thermco designs, manufactures, markets and services large batch thermal processing products which address the oxidation/diffusion and LPCVD steps of the semiconductor fabrication process. Thermco products are used for a broad range of processing applications required in the fabrication of most semiconductor devices, including growing insulating layers on the wafers, diffusing dopants into the silicon structure and depositing insulating or conducting films on the wafer surface. Thermco's products incorporate proprietary technology the Company has developed in the areas of thermal control, gas handling, particle control and automated wafer handling. There are two major configurations of thermal processing equipment, commonly referred to as vertical and horizontal, corresponding to the orientation of their reaction chamber(s). Vertical processing systems represent an increasing portion of the market for oxidation/diffusion and LPCVD processing equipment. Vertical reactors generally consist of a single, fully automated cylindrical reaction chamber, individually controlled by a dedicated computer control system. Vertical systems generally provide greater process uniformity and lower particle contamination than do horizontal systems, due to improved thermal control and an increased ability to maintain environmental integrity, thereby achieving higher yields in wafer processing. Additionally, vertical systems provide more flexibility in manufacturing configurations. Horizontal thermal processing systems, which are typically much larger and less automated than vertical reactors, were the standard of the semiconductor processing equipment industry and are still used for a broad range of processes. Rapid Vertical Processor -- 300 ("RVP-300"). Announced in 1997, the RVP-300 is the latest addition to the vertical furnace product line. RVP-300 is designed for processing of 300mm (12 inch) wafers addressing requirements for 0.18 micron technology and beyond. The design of RVP-300 focuses on maximizing productivity and throughput. This is done by utilizing features such as fast temperature ramp up and ramp down capability, Model Based Temperature Control (MBTC) for optimized temperature control across the wafer, and a dual boat configuration. Initial shipments of the RVP-300 occurred in the second quarter of fiscal 1998. Prices of the RVP-300 range from $1,200,000 to $1,500,000, depending on configuration. Series 9000 Rapid Vertical Processor ("RVP"). Introduced in 1996, the RVP is based on the Advanced Vertical Processor ("AVP") platform, processes both eight inch and six inch wafers and meets sub-.50 micron technology requirements. The RVP features a proprietary and patented design that enables it to ramp up and ramp down temperatures anywhere between twice and ten times as fast as the AVP and offers faster throughput and tighter junction depth control for critical anneals. By utilizing the AVP platform, the Company believes that the RVP, which incorporates key features of the AVP, such as 16-cassette wafer handling and model based temperature control (MBTC), offers the high reliability of the established AVP product line. The typical price range of an RVP system is $1,000,000 to $1,300,000, depending on process configuration. Series 8000 Advanced Vertical Processor ("AVP"). Initially shipped in September 1992, the AVP is a vertical furnace designed to meet the eight and six inch wafer requirements of sub-.50 micron processing. The Series 8000 single tube systems include advanced process control, data acquisition software, advanced automation, a proprietary process chamber design and an option for atmospheric control within the wafer handling area. Key features of the AVP system include storage capacity for sixteen 25-wafer cassettes (400 wafers), and model based temperature control (MBTC) for accurate wafer temperature regulation. The AVP system is designed to offer customers a low cost of ownership, through high productivity and a low square footage requirement. The typical price range of an AVP system is $700,000 to $1,000,000, depending on process configuration. Vertical Thermal Reactor ("VTR"). Thermco's VTR processes wafers from 100mm to 200mm in diameter. It operates under computer control, providing specialized process recipe introduction, cassette-to-cassette automation, monitoring of critical system functions and automated loading of wafers into the reaction chamber. In general, the VTR offers comparable reliability, lower contamination and better process uniformity than horizontal reactors. The VTR can be installed through-the-wall in a customer's clean room facility and is compatible with industry standard software interfaces. The VTR 7000PLUS, in comparison to earlier versions of VTR's, offers improved process control, uniformity, reduced particle levels, higher throughput, internal 6 8 storage capabilities and the industry's standard mechanical interface (SMIF). Typical prices for the Company's VTR products range from approximately $500,000 to $900,000. Horizontal Processing Systems. The typical horizontal system consists of four separately controlled cylindrical reaction chambers which are mounted horizontally, one directly above the other. Horizontal systems are a mature product family. Sales of these systems have been declining in recent years, as semiconductor manufacturers have increasingly installed vertical reactors in their newer fabrication facilities and the Company expects this trend to continue.* However, the Company believes that manufacturers of less complex devices will continue to have some need for horizontal processing systems for the foreseeable future, but at successively declining rates.* In addition, the existing installed base of horizontal processing systems enables the Company to generate revenues through the sale of spare parts and upgrades. Prices for horizontal systems range from approximately $400,000 to $900,000. CUSTOMERS The Company's customer base includes companies that manufacture semiconductor devices primarily for sale to others and companies that manufacture semiconductor devices primarily for internal use. Repeat sales to existing customers represent a significant portion of the Company's processing equipment sales. The Company believes that its installed customer base represents a significant competitive advantage.* By working closely with its established customer base, the Company is able to identify new product development opportunities. The Company's major customers during fiscal 1998 included the following: Hewlett-Packard Phillips Semiconductor IBM ProMos Technologies Intel SGS-Thomson LSI Logic Siemens Motorola White Oak Semiconductor
The Company relies on a limited number of customers for a substantial percentage of its sales. For fiscal 1998, Intel, IBM and Motorola represented 40%, 17% and 13%, respectively, of sales and the Company's largest five customers represented 76% of sales. In fiscal 1997 and 1998, Intel represented a substantial portion of the total sales of both Track and SVGL products. The loss of a significant customer (and in particular the loss of Intel as a Track or SVGL customer -- See "Manufacturing and Raw Materials"), a delay in shipment due to customer rescheduling or any substantial reduction in orders by a significant customer, including reductions in orders due to market, economic or competitive conditions in the semiconductor industry, would adversely affect the Company's business and results of operations.* MARKETING, SALES AND SERVICE The Company markets and sells its products primarily to independent manufacturers of semiconductor devices and computer, telecommunications and other companies that manufacture semiconductor devices for their own use. The market for the Company's products is worldwide. The Company sells its products in the United States principally through its direct sales organization. The Company sells its products overseas through a direct sales staff, independent distributors and independent representatives. The following table sets forth the Company's revenues by geographic area as a percentage of net sales for the three fiscal years ended September 30:
YEARS ENDED SEPTEMBER 30, ------------------------- 1996 1997 1998 ----- ----- ----- United States................................. 66% 72% 65% Western Europe................................ 24 18 31 Far East...................................... 10 10 4
Reliability, which is commonly measured in up-time and mean time between failure, and performance are increasingly important factors by which customers evaluate the potential suppliers of sophisticated 7 9 processing systems. The Company believes that its field service and process support capabilities are major factors in its selection as an equipment supplier. Increasingly, semiconductor manufacturers are requiring seven-day, around the clock, on site or on call support. To meet this need, the Company continues to enhance its training programs and deploy spare part inventories at both customer sites and regional field depots. Service personnel are based in field offices throughout the United States, Western Europe, Japan and the Pacific Rim and increasingly on site at particularly large customer locations. The Company warrants its products against defects in design, materials and workmanship, generally for periods ranging from one to two years. BACKLOG At September 30, 1998 and 1997, the Company had a backlog of approximately $254,130,000 and $437,668,000, respectively. The Company includes in backlog only those orders to which a purchase order number has been assigned by the customer and for which delivery has been specified within 12 months. Such orders are subject to cancellation by the customer with limited charges. Because of the possibility of customer changes in delivery schedules, cancellation of orders and potential delays in product shipments, the Company's backlog as of any particular date may not be representative of actual sales for any succeeding period. As a result of the current semiconductor environment, the Company did receive in each quarter of fiscal 1998 customer deferrals and order cancellations of product with scheduled delivery dates. This led to reduced levels of shipments in the second half of fiscal 1998 and the decline will potentially continue in the first half of fiscal 1999.* There can be no assurance that the Company will not continue to experience customer delivery deferrals, order cancellations or a prolonged period of customer orders at reduced levels, any or a combination of which would have an adverse effect on its operating results.* As of September 30, 1998, the Company had recognized net sales of approximately $53,000,000 from two customers who accepted and took title to the related equipment and agreed to normal credit payment terms, but requested that the Company store the equipment until predetermined shipment dates. RESEARCH, DEVELOPMENT AND RELATED ENGINEERING The market served by the Company is characterized by rapid technological change. Accordingly, the Company's product and process development programs are devoted to the development of new systems and processes, including new generations of products for existing markets, enhancements and extensions of existing products and custom engineering for specific customers. The Company believes that its future success will depend, in part, upon its ability to successfully introduce and manufacture new and enhanced products and processes which satisfy a broad range of customer needs and achieve market acceptance. Accordingly, the Company works closely with semiconductor manufacturers, industry consortia, and research institutions to respond to the industry's evolving product and process requirements. The Company's research staff collaborates with key customers in order to evaluate designs, specifications and prototypes of the Company's new products. The Company believes that in selecting a photolithography equipment manufacturer, customers look for a supplier with a long-term product development strategy and the ability to fund that development since photolithography exposure equipment can represent a substantial portion of the equipment cost of a fabrication facility. Semiconductor manufacturers may be unwilling to rely on a relatively small supplier, such as the Company, for a critical element of the fabrication process if they believe that the Company does not have sufficient capital to implement its product development strategy. The Company depends in part on external sources to fund its photolithography development efforts. During fiscal 1996, the Company entered into agreements with certain customers (the "Participants") whereby each agreed to assist in funding the Company's development of an advanced technology 193 nanometer Micrascan system. In exchange for such funding, each Participant received the right to purchase one such system and, in addition, received a right of first refusal (ratable among such Participants) to all such machines manufactured during the first two years following the initial system shipments. For each initial system ordered, each Participant agreed to fund $5,000,000 in such development costs. The agreements call 8 10 for each Participant to pay $1,000,000 of initial development funding and four subsequent payments of $1,000,000 upon the completion of certain development milestones. The Participants may withdraw from the development program without penalty, but payments made against completed development milestones are not refundable and all preferential rights to future equipment are forfeited. At September 30, 1998, the Company had received $20,000,000 in development funding from six Participants, of which $19,765,000 had been recognized and offset against research and development expenditures. In March 1997, one participant withdrew from the program. There can be no assurances that the other Participants will remain in the program.* In the event that the Company does not receive the funding anticipated under the agreements, it would be required to replace the shortfall from its own funds or other sources. If the Company were required to use its own funds, its research and development expenses would increase and its operating income would be reduced correspondingly. The agreements with the Participants stipulates that if the Company receives funding for the development program in excess of $25,000,000, it will issue, ratably to the Participants, credits totaling such excess in the form of a cash discount which can be applied to the purchase of additional systems by each Participant. The Company anticipates that it will need to continue to make substantial research and development expenditures, particularly in its photolithography products, in order to remain competitive in the semiconductor equipment industry. There is no assurance that the Company will receive all funding which it currently anticipates or that it will be able to obtain future outside funding beyond that which it is currently receiving. If the Company were not able to secure additional external funding, its new product development and product enhancement efforts would either be impaired or would have a material adverse effect on the Company's results of operations.* In connection with the Company's acquisition of SVGL in 1990, SVGL received an equity investment and research and development funding commitments for Micrascan from IBM. Under the terms of the related research and development agreement, SVGL owed IBM certain royalties based on future operating results. During the second quarter of fiscal 1997, the Company satisfied its obligation, recognized an expense of $32,582,000, which represented royalties related to products currently under development, and recorded a prepayment of $5,418,000, which represented royalties related to existing products which are being amortized through fiscal 2000 in proportion to the related product sales. The Company has historically devoted a significant portion of its personnel and financial resources to research and development programs. For fiscal years 1998, 1997, and 1996, total research and development expenditures were approximately $99,000,000, $82,000,000, and $72,000,000, respectively, of which approximately $12,000,000, $8,000,000, and $5,000,000, respectively, was funded by outside parties. Substantially all of the development funding has been received by SVGL for the development of its Micrascan technology and systems. During prior years, the majority of development funding was received from the industry consortium of semiconductor manufacturers, SEMATECH. In fiscal 1997 and 1998, the funding was received primarily from the Participants for the development of the advanced technology 193 nanometer system. COMPETITION The semiconductor equipment industry is intensely competitive. The Company faces substantial competition both in the United States and other countries in all of its products. The Company's competitors include Tokyo Electron, Ltd. ("TEL") and DaiNippon Screen Mfg. Co., Ltd. in photoresist processing equipment; TEL and Kokusai Electric Co., Ltd. in oxidation/diffusion and LPCVD equipment; and Nikon, Canon, ASM Lithography and other suppliers of photolithography exposure equipment, and projection aligners. The trend toward consolidation in the semiconductor processing equipment industry has made it increasingly important to have the financial resources necessary to compete effectively across a broad range of product offerings, to fund customer service and support on a worldwide basis and to invest in both product and process research and development. Significant competitive factors include technology and cost of ownership, a formula which includes such data as initial price, system throughput and reliability and time to maintain or repair. Other competitive factors include familiarity with particular manufacturers' products, established relationships between suppliers and customers, product availability and technological differentiation. Occasionally, the Company has encountered intense price competition with respect to particular orders and has had 9 11 difficulty establishing new relationships with certain customers who have long-standing relationships with other suppliers. The Company believes that outside Japan and the Pacific Rim it competes favorably with respect to most of these factors.* (See "Importance of Japanese and Pacific Rim Markets.") Many of the Company's competitors are Japanese corporations. As a result of the strength of the U.S. dollar in relation to the Japanese yen, the Company is at a disadvantage when competing on the basis of price. In light of the recent economic downturn in certain Asian countries which represent significant markets for such competitors, the Company believes that it may encounter more severe price competition in its non-Asian markets. To compete effectively in these markets, the Company may be forced to reduce prices, which could cause further reduction in net sales and gross margins and, consequently, have a material adverse effect on the Company's financial condition and results of operations.* Certain of the Company's existing and potential competitors have substantially greater name recognition, financial, engineering, manufacturing and marketing resources and customer service and support capabilities than the Company. Additionally, the Company is a relative newcomer in the photolithography exposure market. Nikon, and to a lesser extent Canon, have long established relationships as suppliers of photolithography equipment to most of the semiconductor manufacturers. Although the Company has supplied Track and Thermco equipment to many of these customers, it has not previously sold meaningful quantities of Micrascan photolithography equipment to them. The Company's competitors can be expected to continue to improve the design and performance of their current products and processes and to introduce new products and processes with improved price/performance characteristics. The Micralign products manufactured by SVGL are generally not competitive with steppers for fabrication of semiconductor devices with line widths smaller than 1.25 micron. In marketing Micrascan systems, SVGL continues to face competition from suppliers employing other technologies, principally I-Line and DUV steppers, including Nikon Corp., Canon and ASM Lithography. Additionally, two competitors, Nikon and ASM Lithography have begun shipping initial quantities of .25 micron step-and-scan photolithography systems which utilize DUV light sources, and the Company believes that Canon will begin initial shipments of a similar step-and-scan system in the near future.* The Company believes DUV lithography will be required to fabricate devices with line widths below 0.3 micron.* Semiconductor manufacturers can purchase DUV steppers to produce product at .25 micron line widths. However, the Company believes that as devices increase in complexity and size and require finer line widths, the technical advantages of DUV step-and-scan systems as compared to DUV steppers will enable semiconductor manufacturers to achieve finer line widths with superior critical dimension control to produce higher yields of faster devices.* There can be no assurance that the Company will be successful in competing with such systems.* The availability of limited quantities of .25 micron step-and-scan systems from Nikon, ASM Lithography, Canon or some other supplier may cause customers to delay purchases from the Company until such new products have been evaluated.* Further, if manufacturers of DUV steppers are able to further enhance existing technology to achieve finer line widths sufficiently to erode the competitive and technological advantages of DUV step-and-scan systems, or lithography manufacturers are able to supply step-and-scan systems in sufficient quantity that are technically equal or better than Micrascan, demand for the Micrascan technology may not develop as the Company expects.* IMPORTANCE OF THE JAPANESE AND PACIFIC RIM MARKETS The Company's customers are heavily concentrated in the United States and Europe. The Japanese and Pacific Rim markets (including fabrication plants located in other parts of the world which are operated by Japanese and Pacific Rim semiconductor manufacturers) represent a substantial portion of the overall market for semiconductor manufacturing equipment. To date, neither the Company's shipments into Japan nor the Pacific Rim have been significant. The Company believes that the Japanese companies with which it competes have a competitive advantage because their dominance of the Japanese and Pacific Rim semiconductor equipment market provides them with the sales and technology base to compete more effectively throughout the rest of the world. The Company is not engaged in any significant collaborative effort with any 10 12 Japanese or Pacific Rim semiconductor manufacturers. As a result, the Company may be at a competitive disadvantage to the Japanese equipment suppliers that are engaged in such collaborative efforts with Japanese and Pacific Rim semiconductor manufacturers. The Company believes that it must substantially increase its share of these markets if it is to compete as a global supplier.* Further, in many instances, Japanese and Pacific Rim semiconductor manufacturers fabricate devices such as dynamic random access memory devices ("DRAMs"), with potentially different economic cycles than those affecting the sales of devices manufactured by the majority of the Company's U.S. and European customers. Failure to secure customers in these markets may limit the global market share available to the Company and may increase the Company's vulnerability to industry or geographic downturns.* Recent economic difficulties in certain Asian countries, particularly Korea, will adversely affect the Company's ability to penetrate such markets.* In the past, several of the Company's larger customers have entered into joint ventures ("JV") with European, Japanese or Pacific Rim semiconductor manufacturers. In such cases, the Company has encountered intense price competition from foreign competitors who are suppliers to the non-U.S. member of the JV. Further, in certain instances the Company has not secured the equipment order when the non-U.S. member has had the responsibility for selecting the equipment to be used by the JV in its U.S. operations. There can be no assurance that as the Company's customers form additional alliances, whether in the U.S. or in other parts of the world, that the Company will be successful in obtaining equipment orders or that it will be able to obtain orders with sufficient gross margin to generate profitable transactions, either of which could have an adverse effect on the Company's results of operations.* Throughout the Pacific Rim, the Company is attempting to compete with major equipment suppliers having significant market share and established service and support infrastructures in place. Although the Company has invested in the staffing and facilities that it believes are necessary to sell, service and support customers in the Pacific Rim, it anticipates that it will encounter significant price competition as well as competition based on technological ability.* There can be no assurance that the Company's Pacific Rim operations will be profitable, even if it is successful in obtaining significant sales into this region.* Further, due to recent economic issues in certain Asian countries, particularly Korea, the Company's ability to penetrate such markets has been more difficult. Failure to secure customers in these markets would have an adverse effect on the Company's business and results of operations.* MANUFACTURING AND RAW MATERIALS The Company manufactures its products from standard components and from components manufactured by others according to the Company's design specifications. Track products are manufactured in San Jose, California. Thermco products are primarily manufactured in Orange, California and limited manufacturing in Billingshurst, West Sussex, England, which the Company announced will be closed and product responsibility transferred to Orange, California. Tinsley manufactures optical components in Richmond and North Hollywood, California. SVGL photolithography exposure products are manufactured in Wilton and Ridgefield, Connecticut. From time-to-time, the Company has experienced delays in the introduction of its products and product enhancements due to technical, manufacturing and other difficulties and may experience similar delays in the future.* For example, during fiscal 1996, the Company announced the subsequently terminated 200-APS Track product. Initial shipments of the 200-APS were scheduled to commence during the second quarter of fiscal 1997, and were delayed until the second quarter of fiscal 1998. This delay, as well as industry developments, caused the Company to implement a plan, which was announced on September 30, 1998, to terminate future development and shipments of its 200-APS products, and to concentrate its efforts on completing a new product which has been in development for approximately one year. There can be no assurance that the Company will not experience delays in development or manufacturing problems related to its new product as a result of instability of the design of either the hardware or software elements of the new technology, or be able to efficiently manufacture the new product or other products.* These issues could result in product delivery delays and a subsequent loss of future sales.* Semiconductor manufacturers tend to select either a single supplier or a primary supplier for a certain type of equipment. The Company believes that prolonged delays in delivering initial quantities of newly developed products to multiple customers, whether 11 13 due to the protracted release of product from engineering into manufacturing or due to manufacturing difficulties, could result in semiconductor manufacturers electing to install competitive equipment in their fabrication facilities and could preclude industry acceptance of the Company's products.* For example, the Company's largest Track customer has decided to secure deliveries from another source, a decision the Company believes is primarily due to the delay and subsequent termination of the 200-APS. The release into the market of a new technology Track product will not be accomplished for a number of quarters.* As a result, competitors will increase their market share, and it will be increasingly more difficult for the Company to regain market position.* The Company's inability to effect the timely production of new products or any failure of these products to achieve market acceptance could have a material adverse effect on the Company's business and results of operations.* Historically, the unit cost of the Company's products has been the highest when they are newly introduced into production and cost reductions have come over time through engineering improvements, economies of scale and improvements in the manufacturing process.* As a result, new products have, at times, had an unfavorable impact on the Company's gross margins and results of operations. There can be no assurance that the initial shipments of new products will not have an adverse effect on the Company's profitability or that the Company will be able to attain design improvements, manufacturing efficiencies or manufacturing process improvements over time.* Further, the potential unfavorable effect of newly introduced products on profitability can be exacerbated when there is intense price competition in the marketplace.* The Company believes that its ability to supply systems in volume will be a major factor in customer decisions to commit to the Micrascan technology.* Based upon its forecast of continued growth in demand, the transition from steppers to step-and-scan equipment for photolithography equipment, and potential future demand for advanced lithography products, the Company has been in the process of increasing SVGL's production capacity under an extremely aggressive expansion schedule. In August 1996, as part of this expansion, the Company purchased from The Perkin-Elmer Corporation a 243,000 square foot facility occupied by SVGL in Wilton, Connecticut and an additional 201,000 square foot building, which SVGL now occupies, in Ridgefield, Connecticut. Through fiscal 1998, the Company has invested in significant capital improvements related to the buildings purchased and the equipment required to expand the production capabilities of SVGL. While the Company intends to continue certain of the expansion activities, it may not invest in all of the metrology and other equipment required to maximize manufacturing capacity until industry demand recovers.* However, the Company plans to continue increasing capacity to produce optical components, thus enabling it to quickly respond to customer requirements. Once demand recovers, the timely construction and equipping of facilities to successfully complete the increase in capacity will require the continued recruitment, training and retention of a high quality workforce, as well as the achievement of satisfactory manufacturing results on a scale greater than SVGL has attempted in the past. There can be no assurance that the Company can manage these efforts successfully. Any failure to manage such efforts could result in product delivery delays and a subsequent loss of future revenues. In particular, the Company believes that protracted delays in delivery quantities of current and future Micrascan products could result in semiconductor manufacturers electing to install competitive equipment in their advanced fabrication facilities, which could impede acceptance of the Micascan products on an industry-wide basis.* This could result in the Company's operating results being adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity if net sales, for any reason, do not increase commensurately.* The time required to build a Micascan system is significant. If SVGL is to be successful in supplying increased quantities of Micrascan systems, it will not only need to be able to build more systems, it will need to build them faster.* SVGL will require additional trained personnel, additional raw materials and components and improved manufacturing and testing techniques to both facilitate volume increases and shorten manufacturing cycle time.* To that end, SVGL is continuing to develop its vendor supply infrastructure, and implement manufacturing improvements.* Additionally, the Company believes that once industry demand recovers, it must resume increasing its factory, field service and technical support organization staffing and infrastructure to support the anticipated customer requirements.* There can be no assurance that the Company will not experience manufacturing difficulties or encounter problems in its attempt to increase production and upgrade or expand existing operations.* 12 14 One of the most critical components of the Micrascan systems is the projection optics, which are primarily manufactured by SVGL. As part of its overall investment in capacity, the Company has increased SVGL's optical manufacturing floorspace. The Company believes that in order for SVGL to be a viable supplier of advanced lithography systems in the future, it must successfully reduce the cycle times required to build projection optics.* On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. ("TLI") in exchange for approximately 1,091,000 shares of Company Common Stock. TLI designs, manufactures and sells precision optical components, assemblies and systems to customers in a variety of industries and research endeavors. The primary reasons for the acquisition were TLI's technology and expertise relating to aspherical lenses, a key component of SVGL's photolithography products, the adaptation of certain of TLI's manufacturing processes by SVGL and TLI's commencement of the fabrication of non-aspherical lenses which are currently produced by SVGL. However, there can be no assurance that TLI's manufacturing technology is scaleable, or that such expertise can be transferred without substantial time or expense, if at all.* The inability of SVGL to transfer this production technology for use in processes of a substantially larger scale or the inability of TLI to manufacture non-aspherical lenses for SVGL in sufficient quantities to realize efficiencies of scale could adversely affect the Company's ability to realize any significant benefits from the acquisition of TLI.* The Company believes that protracted delays in delivering quantities of both current and future generations of Micrascan products to multiple customers could result in semiconductor manufacturers electing to install competitive equipment in their advanced fabrication facilities, and could preclude industry acceptance of the Micrascan technology and products.* In addition, the Company's operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity and field service and technical support activities if net sales do not increase commensurately.* SVGL -- Sole Source Materials and Components. Most raw materials and components not produced by the Company are available from more than one supplier. However, certain raw materials, components and subassemblies are obtained from single sources or a limited group of suppliers. Although the Company seeks to reduce its dependence on these sole and limited source suppliers, and the Company has not experienced significant production delays due to unavailability or delay in procurement of component parts or raw materials to date, disruption or termination of certain of these sources could occur and such disruptions could have at least a temporary adverse effect on the Company's business and results of operations.* Moreover, a prolonged inability to obtain certain components could have a material adverse effect on the Company's business and results of operations and could result in damage to customer relationships.* The raw material for a proprietary component of the optical system for the Micrascan is available from only one supplier. The supplier has expanded its capacity to meet SVGL's projected long-term requirements and has created and stored agreed upon quantities of safety stock. There can be no assurance that the supplier will be able to provide acceptable quantities of material required by SVGL.* Additionally, a version of the Company's Micrascan III photolithography system utilizes an Excimer laser that is manufactured in volume by only one supplier, which until the first quarter of fiscal 1998 was the only supplier the Company had determined could meet its specifications. SVGL has recently qualified an additional source of lasers for its current and future versions of Micrascan products, allowing the potential for the integration of such lasers into its system configurations.* However, there can be no assurance that its customers will be receptive to procuring products with lasers from this supplier, or the supplier will be able to provide product of sufficient quantity and quality. If these suppliers were unable to meet their commitments, SVGL would be unable to manufacture the quantity of products required to meet the anticipated future demand, which would have a material adverse effect on the Company's business and results of operations.* PATENTS AND LICENSES The Company owns several domestic and foreign patents relating to the businesses of Track, Thermco and SVGL products. Although the Company has historically relied and continues to rely on the technical and 13 15 marketing competence and creative ability of its personnel, rather than patents, to maintain its competitive position, it has begun to pursue both domestic and foreign patent protection more aggressively. As is typical in the semiconductor equipment industry, the Company has from time to time received, and may in the future receive, communications from third parties asserting patents or copyrights on certain of the Company's products and technologies. Two of the Company's customers have notified the Company that they have received a notice of infringement from Jerome H. Lemelson, alleging that equipment used in the manufacture of electronic devices infringes patents issued to Mr. Lemelson relating to "machine vision" or "barcode reader" technologies. The customers have put the Company on notice that it intends to seek indemnification from the Company for any damages and expenses resulting from this matter if found liable or if the customer settles the claim. The Company cannot predict the outcome of this or any similar claim or its effect upon the Company, and there can be no assurance that any such litigation or claim would not have a material adverse effect upon the Company's financial condition or results of operations.* ENVIRONMENTAL REGULATION To date, the Company has not encountered significant issues regarding the discharge of material into the environment or otherwise relating to the protection of the environment and therefore has not been required to spend significant amounts for capital or non-capital expenditures in order to comply with laws and regulations pertaining thereto. In August 1996, the Company purchased from Perkin-Elmer, approximately 50 acres of land and a 201,000 square foot building thereon (the "Property") located in Ridgefield, Connecticut. At the time the Company purchased the Property, it was aware that certain groundwater and soil contamination was present and that the Property was subject to a clean-up order being performed by Perkin-Elmer under the jurisdiction of the Connecticut Department of Environmental Protection. Agreements between the Company and Perkin-Elmer provide that Perkin-Elmer has sole responsibility for all obligations or liabilities related to the clean-up order. While the Company believes that it has been adequately indemnified, if for some reason Perkin-Elmer was unable to comply or did not comply with the clean-up order, the Company could be required to do so. The Company does not anticipate any material capital expenditures for environmental control facilities in 1999.* BUSINESS INTERRUPTION The Company manufactures its Track products in San Jose, California and substantially all of its Thermco products in Orange, California. Tinsley's optical components are manufactured in Richmond and North Hollywood, California. These California facilities are located in seismically active regions. SVGL's photolithography exposure products are manufactured in Wilton and Ridgefield, Connecticut. If the Company were to lose the use of one of its facilities as a result of an earthquake, flood or other natural disaster, the resultant interruptions in operations would have a material adverse effect on the Company's results of operations and financial condition.* YEAR 2000 As the Year 2000 approaches, a universal issue has emerged regarding how existing application software programs and operating systems can accommodate date values. The Company has completed the modification of its internal-use computer software for the Year 2000. The third party costs associated with such modifications were not material and were expensed in fiscal 1998. The Company does not segregate internal costs incurred to assess and remedy deficiencies related to the Year 2000 problem or modifications to its products, however, the Company has incurred approximately $124,000 with third parties to identify and modify its internal-use computers systems. Although the company believes that the solutions, which were extensively tested, have resulted in its internal-use systems being Year 2000 compliant, there can be no assurance that unforeseen problems that could disrupt operations will arise, or that the Company could be required to expend further cost and effort to solve such problems.* 14 16 The Company has evaluated its products and identified those areas containing date sensitive Year 2000 issues. The Company has informed its customers of ship dates for Year 2000 compliant products and has made available for potential sale the necessary modifications to bring previously shipped products into compliance. The Company is in the process of contacting its suppliers and service providers to ascertain their state of readiness and compliance for Year 2000 issues. The Company will continue to monitor their progress and compliance for these issues. There can be no assurance, however, that the Company's suppliers and service providers will timely provide the Company with products or services which are Year 2000 compliant. Any failure to do so by such third parties could have a material adverse impact on the Company's results of operations.* At this time the Company does not feel it is necessary to develop a contingency plan. As risks are identified, plans will be developed and implemented as required. Although the Company believes its Year 2000 plans will be successful, there can be no assurance that unforeseen problems will not happen which could have a material adverse effect on the Company.* QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The Company attempts to minimize its currency fluctuation risk by actively managing the balances of current assets and liabilities denominated in foreign currencies. The Company does not use derivative financial instruments. A 10% change in the foreign currency exchange rates would not have a material impact on the Company's results of operations. The Company has investments in marketable debt securities that are subject to interest rate risk. However, due to the short-term nature of the Company's debt investments the impact of interest rate changes would not have a material impact on the value of such investments. The Company is also exposed to interest rate risk on its fixed rate debt obligations. At September 30, 1998 fixed rate debt obligations totaled $6,505,000. The fixed rate obligations range between 8.25% to 12% with a weighted average of 8.35% and maturity dates between April 1999 and February 2007. Due to the relatively insignificant principal balance of outstanding debt obligations, the Company does not actively manage the risk associated with these obligations. The impact of interest rate changes would not have a material impact on the Company's results of operations. EMPLOYEES At September 30, 1998, the Company had 2,616 full-time employees and 44 part-time employees and contract personnel, including 531 in research and development, 1,072 in manufacturing, 909 in marketing, sales and customer service and support and 148 in administration. None of the Company's employees are represented by a union. Management considers its relations with its employees to be good. The Company's future success is dependent upon its ability to attract and retain qualified management, technical, sales and support personnel for its operations. In particular, SVGL's future growth is very dependent on the Company's ability to attract and retain key skilled employees, particularly those related to the optical segment of its business. The competition for such personnel is intense. Some key positions in the Company are held by persons who have only recently been appointed to such positions. The Company's growth has increased its dependence on key management personnel. The loss of certain key people, the failure of key persons to perform in their current positions or the Company's inability to attract and retain new key employees could materially adversely affect the Company's performance. 15 17 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- Papken S. Der Torossian........... 59 Chairman of the Board and Chief Executive Officer William A. Hightower.............. 55 President and Chief Operating Officer Russell G. Weinstock.............. 55 Vice President, Finance and Chief Financial Officer Edward A. Dohring................. 65 Vice President, President, SVG Lithography Systems, Inc. Steven L. Jensen.................. 49 Vice President, Worldwide Sales and Service Jeffrey M. Kowalski............... 45 Vice President, President, Thermco Systems Boris Lipkin...................... 51 Vice President, Corporate Larry W. Sonsini.................. 57 Secretary
Mr. Der Torossian became Chairman of the Board and Chief Executive Officer in July 1991, and has been a director of the Company since October 1984. Mr. Hightower became President and Chief Operating Officer in August 1997. He has been a member of the Board of Directors of the Company since 1994. From January 1996 to August 1997, Mr. Hightower was the Chairman of the Board of Directors and Chief Executive Officer of Cadnet Corporation and from August 1989 to December 1995, he was the President and Chief Executive Officer of Telematics International, Inc. Mr. Weinstock has been Vice President of Finance and Chief Financial Officer of the Company and Vice President of Finance and Chief Financial Officer of SVGL since July 1990. Mr. Dohring became a Vice President of the Company in July 1992 and announced his retirement effective December 31, 1998. He became President of SVG Lithography Systems, Inc. in October 1994. From June 1992 to October 1994, he was President of Track. Mr. Jensen became a Vice President of the Company in July 1992 and Vice President, Worldwide Sales in April 1992. Mr. Kowalski became a Vice President of the Company and President of Thermco in January 1995. From November 1992 to January 1995 he was the Vice President of Marketing of Thermco, as well as its Vice President of Technology from November 1993. Mr. Lipkin became a Vice President of the Company in March 1995. From August 1992 to March 1995 he was the Vice President and General Manager of the Thin Film Systems business unit of Varian Associates. Mr. Sonsini has been Secretary since November 1988. He was a member of the Board of Directors of the Company from 1991 to 1997. Mr. Sonsini is a member of the law firm of Wilson Sonsini Goodrich & Rosati, Professional Corporation, counsel to the Company, and is the Chairman of the firm's Executive Committee. Mr. Sonsini serves on the boards of directors of Lattice Semiconductor Corporation, Novell, Inc., and PIXAR. ITEM 2. PROPERTIES. The Company's corporate headquarters are located in San Jose, California in 36,000 square feet of office space. This space is under a lease that expires in 2006 and has a current base rental of approximately $60,000 per month. The Company's Track Systems Division has two leased facilities in San Jose, California. The first is a 90,000 square foot, two-story building with a current monthly base rental of approximately $95,000 and a lease expiration of 2004. The second is also a two-story building consisting of approximately 83,000 square feet. The monthly base rental for this facility is approximately $84,000 under a lease expiring in 1998. 16 18 In March 1996, the Company purchased approximately nine acres of land adjacent to one of the Track facilities in San Jose, California. Although the Company currently has no plans to develop the parcel, it provides the flexibility for future expansion of the Company's Track operations and its thermal processing lab. The Thermco Systems Division has two facilities in Orange, California. The first facility consists of approximately 92,000 square feet with a base monthly rent expense of approximately $50,000 under a lease expiring in 2004. The second facility consists of approximately 77,000 square feet with a base monthly rental expense of approximately $43,500 under a lease expiring in 1999. SVGL owns two facilities in Fairfield County, Connecticut. The first consists of approximately 29 acres of land and buildings totaling approximately 243,000 square feet, located in Wilton, Connecticut. The second consists of approximately 50 acres of land and a 201,000 square foot building located in Ridgefield, Connecticut. As part of its expansion of SVGL's capacity, the Company is in the process of adding an additional 33,000 square feet to the Wilton facility. Tinsley owns two facilities in Richmond, California. The first consists of approximately three acres of land and a building totaling 56,000 square feet. The second consists of two acres of land currently under development for future expansion of the Company's precision optical components. In addition, Tinsley occupies two warehouses in Richmond, California with leases that expire in 1999 with a monthly base rent of approximately $5,600. Tinsley, which owns Century Precision Optics, has two facilities in North Hollywood, California. The first facility consists of approximately 21,000 square feet with a base monthly rent expense of approximately $21,300 under a lease expiring in 2004. The second facility consists of approximately 5,000 square feet with a base monthly rent expense of approximately $4,000. This lease is on a month to month basis. The Company also leases storage and warehouse space near its headquarters in San Jose, office space near its Thermco facilities in Orange, sales and service offices in key locations throughout the United States, Western Europe and the Pacific Basin, and space for a limited manufacturing operation in the United Kingdom. ITEM 3. LEGAL PROCEEDINGS. On or about August 12, 1998, Fullman International and Fullman Company (collectively, "Fullman") initiated a lawsuit in the United States District Court for the District of Oregon alleging a cause of action for fraudulent transfer in connection with a settlement the Company had previously entered into resolving its claims against a Thailand purchaser of the Company's equipment. In its complaint against the Company, the plaintiff, another creditor of the Thailand purchaser, alleges damages of approximately $11,500,000 plus interest. The Company has successfully moved to transfer the case to the United States District Court for the Northern District of California. While the outcome of such litigation is uncertain, the Company believes it has meritorious defenses to the claims and intends to conduct a vigorous defense. However, an unfavorable outcome in this matter could have a material adverse effect on the Company's financial condition.* In addition to the above, the Company, from time to time, is party to various legal actions arising out of the normal course of business, none of which is expected to have a material effect on the Company's financial position or operating results. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of the Company's security holders during the fiscal quarter ended September 30, 1998. 17 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information required by this Item is set forth in Registrant's Annual Report to Stockholders for the fiscal year ended September 30, 1998, at page 32 under the caption "Common Stock Prices," which information is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA. The information required by this Item is set forth in Registrant's Annual Report to Stockholders for the fiscal year ended September 30, 1998, at page 32 under the caption "Five-Year Selected Financial Data," which information is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information required by this Item is set forth in Registrant's Annual Report to Stockholders for the fiscal year ended September 30, 1998, at pages 33 to 46 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," which information is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by this Item is set forth in Registrant's Annual Report to Stockholders for the fiscal year ended September 30, 1998, at pages 13 to 31, which information is incorporated herein by reference. The Company observes a 52-53 week fiscal year ending on the Friday closest to September 30. Under this practice, the Company's last three fiscal years ended September 27, 1996, October 3, 1997, and October 2, 1998. For convenience, this Report and the Company's Consolidated Financial Statements refer to all such fiscal years as ending at September 30. Fiscal 1996 and fiscal 1998 each included 52 weeks. Fiscal 1997 included 53 weeks. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS. Not applicable. With the exception of the information expressly incorporated by reference from the Annual Report to Stockholders into Parts II and IV of this Form 10-K, the Company's Annual Report to Stockholders is not to be deemed filed as part of this report. PART III Certain information required by Part III is omitted from this Report in that the Registrant will file its definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 23, 1999, pursuant to Regulation 14A of the Securities Exchange Act of 1934 (the "Proxy Statement"), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. (a) Executive Officers. See the section entitled "Executive Officers of the Registrant" in Part I, Item 1 of this Report. (b) Directors. The information required by this Item is incorporated by reference to the section entitled "Election of Directors" in the Proxy Statement. 18 20 ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to the section entitled "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference to the section entitled "Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to the section entitled "Certain Transactions" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K. (a) 1. FINANCIAL STATEMENTS. The following consolidated financial statements of the Company included in the Company's Annual Report to Stockholders for the fiscal year ended September 30, 1998, are incorporated by reference: Independent Auditors' Report. Consolidated Balance Sheets at September 30, 1998 and 1997. Consolidated Statements of Operations for the Years Ended September 30, 1998, 1997 and 1996. Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the Years Ended September 30, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. 2. SUPPLEMENTAL SCHEDULE. Independent Auditors' Report. Schedule II -- Valuation and Qualifying Accounts. Financial statement schedules, other than the schedule listed above, have been omitted because the required information is contained in the Consolidated Financial Statements and the Notes thereto, or because such schedules are not required or applicable. 19 21 3. EXHIBITS.
EXHIBIT NO. EXHIBIT ----------- ------- 10.46 First Amendment to Credit Agreement, dated October 23, 1998, by and among the Registrant, ABN Amro Bank, N.V. as Agent and certain Lenders with respect thereto. 10.47 Retirement Agreement, dated as of November 16, 1998, by and between the Registrant and Edward A. Dohring. 13.1 Selected data from Annual Report to Stockholders for fiscal year ended September 30, 1998. 21.1 Registrant's wholly-owned subsidiaries are (i) SVG Lithography Systems, Inc., a Delaware corporation (SVGL), (ii) Tinsley Laboratories, Inc., a California corporation ("TLI"), (iii) Silicon Valley Group, K.K., a Japanese corporation, (iv) SVG International Service, a California corporation ("SVG International"), (v) Silicon Valley Group FSC Incorporated, a Barbados corporation, (vi) SVG Israel, Inc., a Delaware corporation, (vii) SVG Thailand, Inc., a Delaware corporation and (viii) SVG Korea, Inc., a Korean corporation. SVG Lithography Japan Co., Ltd., a Japanese corporation, Silicon Valley Group B.V., a Netherlands corporation, SVG Lithography Systems Korea, Inc., a Delaware corporation, SVG France S.A.R.L., a French corporation, and SVG Lithography Systems FSC, Inc., a Barbados corporation are wholly-owned by SVGL. Century Precision Industries, Inc., a California corporation is wholly-owned by TLI. SVG Europe Limited, a United Kingdom corporation ("SVG Europe"), Silicon Valley Group Deutschland GmbH, a German corporation, SVG Systems (Asia) Pte. Ltd., a Singapore corporation and Thermco Systems (Far East) Limited, a Hong Kong corporation are wholly-owned by SVG International. UK Systems Limited, an English corporation, is wholly-owned by SVG Europe. 23.1 Consent of Deloitte & Touche LLP, independent auditors. 24.1 Power of Attorney (see page 22). 27 Financial Data Schedule.
- --------------- (b) REPORTS ON FORM 8-K. None (c) EXHIBITS. See (a) above. (d) FINANCIAL STATEMENT SCHEDULES. See (a) above. 20 22 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Silicon Valley Group, Inc.: We have audited the consolidated financial statements of Silicon Valley Group, Inc. and subsidiaries as of September 30, 1997 and 1998, and for each of the three years in the period ended September 30, 1998, and have issued our report thereon dated October 26, 1998; such consolidated financial statements and report are included in your 1998 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Silicon Valley Group, Inc., listed in Item 14(a)2. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP San Jose, California October 26, 1998 21 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. December 30, 1998 SILICON VALLEY GROUP, INC. By: /s/ PAPKEN S. DER TOROSSIAN ------------------------------------ Papken S. Der Torossian Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Papken S. Der Torossian and Russell G. Weinstock, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE ---------- ----- ---- /s/ PAPKEN S. DER TOROSSIAN Chairman of the Board, December 30, 1998 - ----------------------------------------------------- Chief Executive Officer Papken S. Der Torossian and Director (Principal Executive Officer) /s/ WILLIAM A. HIGHTOWER President Chief December 30, 1998 - ----------------------------------------------------- Operating Officer and William A. Hightower Director /s/ RUSSELL G. WEINSTOCK Vice President, Finance December 30, 1998 - ----------------------------------------------------- and Chief Financial Russell G. Weinstock Officer (Principal Financial and Accounting Officer) /s/ WILLIAM L. MARTIN Director December 30, 1998 - ----------------------------------------------------- William L. Martin /s/ NAM P. SUH Director December 30, 1998 - ----------------------------------------------------- Nam P. Suh
22 24
SIGNATURES TITLE DATE ---------- ----- ---- /s/ LAWRENCE TOMLINSON Director December 30, 1998 - ----------------------------------------------------- Lawrence Tomlinson /s/ KENNETH M. THOMPSON Director December 30, 1998 - ----------------------------------------------------- Kenneth M. Thompson
23 25 SILICON VALLEY GROUP SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED BALANCE AT BEGINNING TO COSTS AND END DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) OF PERIOD ----------- ---------- ------------ ------------- ---------- YEAR ENDED 9/30/96: Allowance for Doubtful Accounts................ $ 4,156 $ 2,044 $ (122) $ 6,078 Product Warranty Reserves...................... 32,603 64,068 (53,772) 42,899 YEAR ENDED 9/30/97: Allowance for Doubtful Accounts................ 6,078 7,725 (7,009) 6,794 Product Warranty Reserves...................... 42,899 42,320 (41,685) 43,534 YEAR ENDED 9/30/98: Allowance for Doubtful Accounts................ 6,794 3,273 (1,835) 8,232 Product Warranty Reserves...................... 43,534 64,138 (58,729) 48,943
- --------------- (1) Write-offs of uncollectible accounts and costs incurred for warranty repairs. 26 INDEX TO EXHIBITS
EXHIBIT NO. EXHIBIT - ----------- ------- 10.46 First Amendment to Credit Agreement, dated October 23, 1998, by and among the Registrant, ABN Amro Bank, N.V. as Agent and certain Lenders with respect thereto. 10.47 Retirement Agreement, dated as of November 16, 1998, by and between the Registrant and Edward A. Dohring. 13.1 Selected data from Annual Report to Stockholders for fiscal year ended September 30, 1998. 23.1 Consent of Deloitte & Touche, independent auditors. 27 Financial Data Schedule.
27 [SVG LOGO] [Recycled logo] Printed on recycled paper EX-10.46 2 FIRST AMENDMENT TO CREDIT AGREEMENT DATED 10/23/98 1 EXHIBIT 10.46 FIRST AMENDMENT TO CREDIT AGREEMENT THIS FIRST AMENDMENT TO CREDIT AGREEMENT (this "Amendment"), dated as of October 23, 1998, is entered into by and among: (1) SILICON VALLEY GROUP, INC., a Delaware corporation ("Borrower"); (2) Each of the financial institutions listed in Schedule I to the Credit Agreement referred to in Recital A below (collectively, the "Lenders"); and (3) ABN AMRO BANK N.V., acting through its San Francisco International Branch, as agent for Lenders (in such capacity, "Agent"). RECITALS A. Borrower, the Lenders and Agent are parties to a Credit Agreement dated as of June 30, 1998 (the "Credit Agreement"). B. Borrower has requested the Lenders and Agent to amend the Credit Agreement in certain respects. C. The Lenders and Agent are willing so to amend the Credit Agreement upon the terms and subject to the conditions set forth below. AGREEMENT NOW, THEREFORE, in consideration of the above recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Borrower, the Lenders and Agent hereby agree as follows: 1. DEFINITIONS, INTERPRETATION. All capitalized terms defined above and elsewhere in this Amendment shall be used herein as so defined. Unless otherwise defined herein, all other capitalized terms used herein shall have the respective meanings given to those terms in the Credit Agreement, as amended by this Amendment. The rules of construction set forth in Section I of the Credit Agreement shall, to the extent not inconsistent with the terms of this Amendment, apply to this Amendment and are hereby incorporated by reference. 2. AMENDMENTS TO CREDIT AGREEMENT. Subject to the satisfaction of the conditions set forth in Paragraph 4 below, the Credit Agreement is hereby amended as follows: (a) Subparagraph 5.03(b) is hereby amended to read in its entirety as follows: 2 (b) Fixed Charge Coverage Ratio. Borrower shall not permit its Fixed Charge Coverage Ratio for any period set forth below to be less than the ratio set forth opposite such period below: The quarter ending on July 2, 1999 2.00; The consecutive two-quarter period beginning on April 3, 1999 and ending on October 1, 1999 2.50; The consecutive three-quarter period beginning on April 3, 1999 and ending on December 31, 1999, and each consecutive four- quarter period ending on the last day of each quarter thereafter 3.50. (b) Subparagraph 5.03(d) is hereby amended to read in its entirety as follows: (d) Tangible Net Worth. Borrower shall not permit its Tangible Net Worth on the last day of any fiscal quarter (such date to be referred to in this Subparagraph 5.03(d) as a "determination date") which occurs on or after October 2, 1998 (such date to be referred to in this Subparagraph 5.03(d) as the "base date") to be less than the sum on such determination date of the following: (i) Five Hundred Twenty Eight Million Seven Hundred Seventy Seven Thousand Dollars ($528,777,000); plus (ii) Eighty percent (80%) of the sum of Borrower's consolidated quarterly net income (ignoring any quarterly losses) for each fiscal quarter after the base date through and including the fiscal quarter ending on the determination date; plus (iii) Seventy-five percent (75%) of the Net Proceeds of all Equity Securities issued by Borrower and its Subsidiaries (to Persons other than Borrower or its Subsidiaries) during the period commencing on the base date and ending on the determination 2 3 date; 3 4 plus (iv) Seventy-five percent (75%) of the principal amount of all debt securities of Borrower and its Subsidiaries converted into Equity Securities of Borrower and its Subsidiaries during the period commencing on the base date and ending on the determination date. minus (v) The lesser of (A) the aggregate amount paid by Borrower (including reasonable expenses incurred in connection therewith) to repurchase up to one million shares of its common stock during the period commencing on the base date and ending on the determination date and (B) $10,000,000. (c) Subparagraph 5.03(e) is hereby amended to read in its entirety as follows: (e) Profitability. (i) For the quarter ending October 2, 1998, Borrower shall not permit its Adjusted Net Income to be a loss exceeding $30,000,000. (ii) During the period October 3, 1998 - April 2, 1999, Borrower shall not permit (A) its Adjusted Net Income for any quarter to be a loss exceeding $15,000,000 or (B) the sum of all such quarterly losses (excluding any quarterly profits) to exceed $25,000,000. (iii) During the period April 3, 1999 - December 31, 1999, Borrower shall not permit the sum of all quarterly losses based upon its Adjusted Net Income (excluding any quarterly profits) to exceed $5,000,000. (iv) Thereafter, Borrower shall not permit (A) its Adjusted Net Income for any quarter to be a loss exceeding $10,000,000, (B) its Adjusted Net Income to be a loss in more than two quarters in any consecutive four-quarter period (commencing with the consecutive four-quarter period ending on March 31, 2000) or (C) its Adjusted Net Income for any consecutive four-quarter period (commencing with the consecutive four-quarter period ending on March 31, 2000) to be a loss. 3. REPRESENTATIONS AND WARRANTIES. Borrower hereby represents and warrants to Agent and the Lenders that the following are true and correct on the date of this Amendment and 4 5 that, after giving effect to the amendments set forth in Paragraph 2 above, the following will be true and correct on the Effective Date (as defined below): (a) The representations and warranties of Borrower and its Subsidiaries set forth in Paragraph 4.01 of the Credit Agreement and in the other Credit Documents are true and correct in all material respects; (b) No Default has occurred and is continuing; and (c) Each of the Credit Documents is in full force and effect. (Without limiting the scope of the term "Credit Documents," Borrower expressly acknowledges in making the representations and warranties set forth in this Paragraph 3 that, on and after the date hereof, such term includes this Amendment.) 4. EFFECTIVE DATE. The amendments effected by Paragraph 2 above shall become effective on October 23, 1998 (the "Effective Date"), subject to receipt by Agent and the Lenders on or prior to the Effective Date of the following, each in form and substance satisfactory to Agent, the Lenders and their respective counsel: (a) This Amendment duly executed by Borrower, the Required Lenders and Agent; (b) A Certificate of the Secretary of Borrower, dated the Effective Date, certifying that the Restated Certificate of Incorporation and Bylaws of Borrower, in the form delivered to Agent on the Closing Date, are in full force and effect and have not been amended, supplemented, revoked or repealed since such date; (c) A nonrefundable amendment fee equal to 0.075% of each Lender's Commitment to be paid to each Lender that executes this Amendment on or before October 23, 1998; and (d) Such other evidence as Agent or any Lender may reasonably request to establish the accuracy and completeness of the representations and warranties and the compliance with the terms and conditions contained in this Amendment and the other Credit Documents. 5. EFFECT OF THIS AMENDMENT. On and after the Effective Date, each reference in the Credit Agreement and the other Credit Documents to the Credit Agreement shall mean the Credit Agreement as amended hereby. Except as specifically amended above, (a) the Credit Agreement and the other Credit Documents shall remain in full force and effect and are hereby ratified and confirmed and (b) the execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power, or remedy of the Lenders or Agent, nor constitute a waiver of any provision of the Credit Agreement or any other Credit Document. 5 6 6. MISCELLANEOUS. (a) Counterparts. This Amendment may be executed in any number of identical counterparts, any set of which signed by all the parties hereto shall be deemed to constitute a complete, executed original for all purposes. (b) Headings. Headings in this Amendment are for convenience of reference only and are not part of the substance hereof. (c) Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of California without reference to conflicts of law rules. 6 7 IN WITNESS WHEREOF, Borrower, Agent and the Lenders have caused this Amendment to be executed as of the day and year first above written. BORROWER: SILICON VALLEY GROUP, INC. By: /s/ Russell G. Weinstock ----------------------------------------- Name: Russell G. Weinstock --------------------------------------- Title Vice President of Finance and CFO -------------------------------------- AGENT: ABN AMRO BANK, N.V. By: /s/ Robin S. Yim ----------------------------------------- Name: Robin S. Yim --------------------------------------- Title: Group Vice President -------------------------------------- By: /s/ Richard R. DaCosta ----------------------------------------- Name: Richard R. DaCosta --------------------------------------- Title: Vice President -------------------------------------- LENDERS: ABN AMRO BANK, N.V. By: /s/ Robin S. Yim ----------------------------------------- Name: Robin S. Yim --------------------------------------- Title: Group Vice President -------------------------------------- By: /s/ Richard R. DaCosta ----------------------------------------- Name: Richard R. DaCosta --------------------------------------- Title: Vice President -------------------------------------- COMERICA BANK-CALIFORNIA By: /s/ Alan Jepsen ----------------------------------------- Name: Alan Jepsen --------------------------------------- Title: Vice President and Assistant Manager -------------------------------------- 7 8 FLEET NATIONAL BANK By: /s/ Mathew M. Glauninger ----------------------------------------- Name: Mathew M. Glauninger --------------------------------------- Title: Vice President -------------------------------------- KEYBANK NATIONAL ASSOCIATION By: /s/ Mary K. Young ----------------------------------------- Name: Mary K. Young --------------------------------------- Title: Assistant Vice President -------------------------------------- WELLS FARGO BANK, N.A. By: /s/ Karen Barone ----------------------------------------- Name: Karen Barone --------------------------------------- Title: Vice President -------------------------------------- 8 EX-10.47 3 RETIREMENT AGREEMENT DATED 12/31/98 1 EXHIBIT 10.47 RETIREMENT AGREEMENT In recognition of your service to Silicon Valley Group, Inc. the Company would like to recognize your retirement with the following exiting package, which will be executed upon your signature on this general release: This Agreement ("Agreement") is made as of the 16th day of November, 1998, by and between Edward Dohring ("Dohring"), his assigns, his estate and his personal representative (collectively referred to as "Dohring"), and the Silicon Valley Group, Inc., and its subsidiary Silicon Valley Group Lithography, Inc. (jointly referred to as "SVG" or as the "Company"), their successors or assigns. In consideration of the mutual promises made herein, Dohring and SVG hereby agree as follows: 1. Retirement. (a) Retirement Date. Dohring's Retirement from the Company will occur as of midnight December 31, 1998, (the "Retirement"). Following the retirement, Dohring will be paid eighteen months salary ($450,000.00) as well as a bonus equal to any bonus received over the 18 month period immediately preceding the effective date of this Agreement, less legally required withholdings. Such payments will commence on January 1, 1999, and will be paid bi-weekly thereafter. In addition, Dohring will receive payment of the bonus monies in the same manner and in the same time frame as he had in received such payments in the past. (b) Medical and dental coverage will be paid through July 31, 2000, and Dohring will be eligible for COBRA benefits thereafter in accordance with applicable laws. (c) Dohring will remain employed in his current position with full authority and compensation until the retirement date. (d) All of Dohring's accrued vacation time will be distributed in a lump sum payment after January 1, 1999 consistent with normal Company policy. All of Dohring's accrued, but unused sick time will be relinquished as of the retirement date, also consistent with established Company policy. Following midnight, December 31, 1998, both Dohring and the Company agree that Dohring will cease to accrue any further sick leave or vacation benefits. (e) For a period of eighteen months following the retirement date the Company will continue to pay Dohring his automobile allowance, said payments to be made bi-weekly. (f) For a period of eighteen months following the retirement date, the Company will continue to enroll Dohring in the American Airlines Platinum Club. 2 2. Benefits. (a) Dohring shall have the right to his health and life insurance benefits through July 31, 2000, there after individual coverage pursuant to COBRA. (b) Term Life Insurance, Annual Physical and Tax Preparation will be continued for a period of 18 months from Retirement date. (c) Dohring will have review and input privilege into press announcement regarding his Retirement. 3. Relocation. The company will pay relocation cost from Wilton, Connecticut to Rochester, New York and related storage transfer costs in an amount not to exceed $5,000.00. 4. No Defamation. Dohring agrees that he will not, before or after the Retirement Date, defame or disparage the Company, its products, its technologies or any other aspect of its business or operations or any employee, officer, director or consultant of the Company. The Company agrees that it will not defame or disparage Dohring or any services performed by Dohring for the Company during the course of his employment, before or after the retirement date. 5. Options. Under the terms of the Company's Stock Option Plan, Dohring would be entitled to exercise options for 133,385 shares as of December 31, 1998. The Company will agree to extend the exercise period on these options through July 31, 2000, subject to approval of the SVG Board of Directors. 6. Waiver and Release of Claims. (a) Dohring and the Company hereby waives and releases, and agrees not to sue concerning, any and all claims and causes of action that he has, may have or at any time has had, whether known or unknown, against the other and/or any of their respective affiliates, employees, officers, or directors or parent or Subsidiary corporations, successors, assigns or personal representatives for any reason including, without limitation, any and all claims relating to or arising from his employment relationship with SVG and the termination of that relationship; any and all tort or other claims for wrongful discharge of employment; any and all claims for breach of contract, both expressed and implied; any and all claims arising out of any other laws or regulations relating to 2 3 employment or employment discrimination; and any attorneys' fees and costs. This waiver shall include but not be limited to any and all claims and causes of action pursuant to any local, state, or federal law, common or statutory, including but not limited to Title VII of the Civil Rights Act of 1964, as amended, the Age Discrimination in Employment Act of 1967, the Employee Retirement Income Security Act of 1974, Family Medical Leave Act, American with Disabilities Act, as amended and any similar statutes arising under California Law. There shall be excepted from this waiver any claims of Dohring to receive the salary and benefits set forth in this Agreement. (b) Dohring specifically acknowledges that he is waiving and releasing any rights he may have under the Age Discrimination in Employment Act of 1967 ("ADEA") and that this waiver and release is knowing and voluntary. Dohring and the Company agree that this waiver and release does not apply to any rights or claims that may arise under ADEA after the effective date of this Agreement. Dohring acknowledges that the consideration given for this waiver and release is in addition to anything of value to which Dohring was already entitled. Dohring further acknowledges that he has been advised by this writing that (a) he should consult with an attorney prior to executing this Agreement; (b) he has at least twenty-one (21) days within which to consider this Agreement; (c) he has at least seven (7) days following the execution of this Agreement to revoke the Agreement; and (d) this Agreement shall not be effective until the revocation period has expired. 7. Civil Code Section 1542. Dohring and SVG each acknowledges that each is familiar with the provisions of Section 1542 of the Civil Code of the State of California, which section states as follows: "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." Dohring and SVG each hereby expressly waives any right each may have under the above referenced code section, as well as under any statute or common law principles of similar effect. 8. Indemnification The Company agrees to insure and indemnify Dohring and hold him harmless (including any and all costs of defense) from any threatened or actual claims, suits or actions which are directed against him, or which involve him, in any proceedings where such claims arise from Dohring's actions during his Employment with the Company that were undertaken within the course and scope of his authority as an employee. 3 4 9. Proprietary Information. (a) Dohring represents to the Company that Dohring has complied with and will continue to comply with all of the terms of the Employment, Confidential, Information and Invention Assignment Agreement which Dohring entered into when Dohring became an employee of the Company. Dohring represents that, in compliance with the Employment, Confidential, Information and Invention Assignment Agreement, Dohring has reported all inventions conceived or made by Dohring as required under such agreement. Dohring represents to the Company that Dohring does not have in his possession, and has not failed to return to the Company, any proprietary materials or other property belonging to the Company. (b) The Company acknowledges that nothing in this Agreement limits Dohring's right to seek and accept employment of his choosing after the retirement date, without restriction, so long as he adheres to all of the terms and conditions of the Employment, Confidential, Information and Invention Assignment Agreement referenced above. 10. Confidentiality. Dohring shall not disclose the terms of this Agreement to anyone, except for his legal advisors, tax advisors, administrative assistant's name (on a confidential basis), and immediate family members (including significant other's name), without the written consent of the company unless required to do so by law. 11. Severability. If any provision hereof becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement shall continue in full force and effect without such provision. 12. Notice and Mailings. Any notice required or permitted hereunder shall be given in writing and shall be deemed effectively given upon personal delivery or upon deposit in the United States Post Office with postage and fees prepaid, addressed to each of the other parties thereunto entitled at the following addresses or at such other addresses as a party may designate by ten days' advance written notice to each of the other parties thereto: (a) All notice and mailings to SVG, shall be addressed to: Silicon Valley Group, Inc. 101 Metro Drive, Suite 400 San Jose, CA 95110 4 5 (b) All financial reporting documents relating to Dohring and attributable to the 1998 calendar year which concern the Internal Revenue Service, the State of Connecticut, and/or any other governmental entity should be addressed to: Mr. Edward Dohring (c) All other documents and payments relating to Dohring, regardless of date, should be addressed to: Mr. Edward Dohring 13. Counterparts. This Agreement may be executed in counterparts, and each counterpart shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the undersigned. 14. California Law. This Agreement shall be construed and governed by the laws of the State of California. 15. Effective Date. This Agreement is effective seven (7) days after both Parties have signed it. 16. Entire Agreement. This Agreement represents the entire agreement and understanding between the Company and Employee concerning Employee's Retirement from the Company, and supersedes and replaces any all prior agreements and understandings concerning Employee's relationship with the Company and his compensation by the Company. 5 6 17. No Oral Modifications. This Agreement may only be amended in writing signed by Dohring and an officer of the Company. 18. Dohring's Legal Expenses. As urged by the Company, Dohring has sought out legal advise from the counsel of his choice and, as a result, has incurred fees and costs. The Company hereby agrees to reimburse Dohring for such expenses actually incurred, not to exceed $5,000.00, which should be claimed on Dohring's final business expense submission. 19. Final Business Expenses. Dohring shall submit his final business expenses report not later than January 31, 1999 and the Company shall promptly tender reimbursement to him consistent with its normal practice. IN WITNESS WHEREOF, the parties have executed this Agreement on the respective dates set forth below. SILICON VALLEY GROUP, INC. Dated: November 16, 1998 By /s/ William A. Hightower --------------------------------------- William A. Hightower, President and COO EDWARD DOHRING, an individual Dated: November 25, 1998 /s/ Edward A. Dohring ------------------------------------------- Edward A. Dohring 6 EX-13.1 4 SELECTED DATA FROM ANNUAL REPORT TO STOCKHOLDERS 1 EXHIBIT 13.1 CONSOLIDATED BALANCE SHEETS
September 30 (in thousands, except share and per share amounts) 1997 1998 - ----------------------------------------------------------------------------------------------------- ASSETS Current Assets: Cash and equivalents $129,689 $ 121,575 Temporary investments 76,972 28,425 Accounts receivable (net of allowance for doubtful accounts of $6,794 and $8,232 respectively) 145,794 121,562 Refundable income taxes -- 15,000 Inventories 228,453 212,975 Prepaid expenses and other assets 7,507 7,485 Deferred taxes 5,590 22,740 ------------------------------ Total current assets 594,005 529,762 Property and equipment, net 150,985 191,022 Deposits and other assets 6,614 6,070 Intangible assets, net 4,413 3,736 ------------------------------ Total $756,017 $ 730,590 ------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 43,707 $ 25,346 Accrued liabilities 127,449 130,532 Current portion of long term debt 1,848 640 Income taxes payable 515 1,284 ------------------------------ Total current liabilities 173,519 157,802 Long term debt 6,515 5,865 Deferred and other liabilities 2,873 5,393 Commitments (See Notes 8, 12 and 13) -- -- Stockholders' Equity: Convertible Redeemable Preferred Stock--$0.01 par value, shares authorized: 1,000,000; none outstanding -- -- Common Stock--$0.01 par value, shares authorized: 100,000,000; shares outstanding: 1997: 32,272,342; 1998: 32,696,394 399,663 404,462 Retained earnings 173,961 160,384 Minimum pension liability (274) (274) Cumulative translation adjustment (240) (3,042) ------------------------------ Stockholders' equity 573,110 561,530 ------------------------------ Total $756,017 $730,590 - -----------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 13 2 CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended September 30 (in thousands, except per share amounts) 1996 1997 1998 - ------------------------------------------------------------------------------------------ Net sales $ 657,337 $ 614,226 $ 608,625 Cost of sales Cost of net sales 383,715 378,114 389,279 Restructuring charges -- -- 19,117 --------------------------------------------- Gross profit 273,622 236,112 200,229 Operating expenses: Research, development and related engineering 67,323 74,311 87,272 Marketing, general and administrative 119,238 134,642 130,615 Settlement of royalty obligation -- 32,582 -- Restructuring and related charges -- -- 14,563 --------------------------------------------- Operating income (loss) 87,061 (5,423) (32,221) Interest and other income 13,504 10,639 6,082 Interest expense (756) (1,018) (1,018) --------------------------------------------- Income (loss) before income taxes and minority interest 99,809 4,198 (27,157) Provision (benefit) for income taxes 34,984 1,514 (13,580) Minority interest 726 92 -- --------------------------------------------- Net income (loss) $ 64,099 $ 2,592 $ (13,577) --------------------------------------------- Net income (loss) per share--basic $ 2.09 $ 0.08 $ (0.42) --------------------------------------------- Shares used in per share computations--basic 30,657 31,635 32,438 --------------------------------------------- Net income (loss) per share--diluted $ 2.06 $ 0.08 $ (0.42) --------------------------------------------- Shares used in per share computations--diluted 31,122 32,414 32,438 ---------------------------------------------
See Notes to Consolidated Financial Statements. 14 3 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Minimum Cumulative ------------------------- Retained Pension Translation (in thousands except shares) Shares Amount Earnings Liability Adjustment Total - ----------------------------------------------------------------------------------------------------------------------------------- Balances, September 30, 1995 26,244,853 $ 251,024 $ 107,718 $ (128) $ -- $ 358,614 Sale of Common Stock, net of issuance costs 4,025,000 126,196 126,196 Warrants exercised, net 701,923 -- Stock options exercised 115,194 883 883 Employee stock purchase plan 112,178 954 954 Tax benefit of stock option transactions 496 496 Net income 64,099 64,099 - ----------------------------------------------------------------------------------------------------------------------------------- Balances, September 30, 1996 31,199,148 379,553 171,817 (128) -- 551,242 Stock issued in settlement of royalty obligation 489,296 9,994 9,994 Stock options exercised 372,464 3,853 3,853 Employee stock purchase plan 216,709 3,753 3,753 Tax benefit of stock option transactions 2,532 2,532 Cumulative translation adjustment (240) (240) Pension liability (146) (146) Adjustment to conform TLI fiscal year (5,275) (22) (448) (470) Net income 2,592 2,592 - ----------------------------------------------------------------------------------------------------------------------------------- Balances, September 30, 1997 32,272,342 399,663 173,961 (274) (240) 573,110 Stock options exercised 158,254 866 866 Employee stock purchase plan 265,798 3,196 3,196 Tax benefit of stock option transactions 737 737 Cumulative translation adjustment (2,802) (2,802) Net loss (13,577) (13,577) - ----------------------------------------------------------------------------------------------------------------------------------- Balances, September 30, 1998 32,696,394 $ 404,462 $ 160,384 $ (274) $ (3,042) $ 561,530 - -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 15 4 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30 (in thousands) 1996 1997 1998 - -------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income (loss) $ 64,099 $ 2,592 $ (13,577) Reconciliation to net cash provided by operating activities: Depreciation and amortization 13,875 27,605 39,171 Settlement of royalty obligation -- 27,582 -- Amortization of intangibles 377 751 848 Deferred income taxes (5,562) 948 (17,150) Adjustment to conform TLI fiscal year -- (470) -- Minority interest 726 92 -- Changes in assets and liabilities: Accounts receivable (28,729) (14,250) 24,232 Refundable income taxes -- -- (15,000) Inventories (59,177) (13,249) 15,478 Prepaid expenses 145 (120) 22 Deposits and other assets (278) (1,159) 373 Accounts payable (4,514) 7,481 (18,361) Accrued liabilities 38,519 (9,204) 5,617 Income taxes payable 4,596 (3,416) 769 Minimum pension liability -- (146) -- - -------------------------------------------------------------------------------------------- Net cash provided by operating activities 23,589 25,037 22,422 - -------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Purchases of temporary investments, held to maturity (88,647) -- -- Purchases of temporary investments, available for sale (43,220) (109,872) (10,190) Maturities of temporary investments, held to maturity 102,380 -- -- Maturities of temporary investments, available for sale -- 76,120 58,737 Purchases of property and equipment (68,836) (89,932) (79,208) Purchase of minority interest in subsidiary -- (3,000) -- - -------------------------------------------------------------------------------------------- Net cash used for investing activities (98,323) (126,684) (30,661) - -------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Sale of Common Stock 128,033 7,332 4,799 Proceeds from borrowing 599 6,462 250 Repayment of debt (1,285) (1,406) (2,108) - -------------------------------------------------------------------------------------------- Net cash provided by financing activities 127,347 12,388 2,941 - -------------------------------------------------------------------------------------------- Effect of Exchange Rate Changes on Cash (177) (839) (2,816) - -------------------------------------------------------------------------------------------- Increase (decrease) in cash and equivalents 52,436 (90,098) (8,114) Cash and equivalents: Beginning of year 167,351 219,787 129,689 - -------------------------------------------------------------------------------------------- End of year $ 219,787 $ 129,689 $ 121,575 - -------------------------------------------------------------------------------------------- Non-Cash Investing and Financing Activities: Common Stock issued in settlement of royalty obligation $ -- $ 9,994 $ -- - -------------------------------------------------------------------------------------------- Tax benefit of stock option transactions $ 496 $ 2,532 $ 737 - --------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 16 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES LINE OF BUSINESS. The Company designs, manufactures and markets semiconductor wafer processing equipment used in the fabrication of integrated circuits. CERTAIN RISKS AND UNCERTAINTIES. The semiconductor industry is highly cyclical and has, historically, experienced periodic downturns that have had a severe effect on the industry's demand for semiconductor wafer processing equipment. An extension of the current downturn or future such downturns are likely to have an adverse effect on the Company's results of operations. The Company relies on a limited number of major customers for a substantial percentage of its net sales. The loss of or any substantial reduction or rescheduling of orders by any such customer could adversely affect the Company's business and results of operations. CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investments and trade receivables. The Company places its cash equivalents and temporary investments in high-grade instruments, which it places for safe keeping with high-quality financial institutions. Further, by policy, it limits the amount of credit exposure with any one counterparty and the amount of total investment through any one financial institution or in any one type of investment. The Company sells its systems to both domestic and international semiconductor manufacturers. The Company performs ongoing credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. The Company maintains an allowance for uncollectible accounts receivable. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company regularly assesses those estimates and, while actual results may differ, management believes that the estimates are reasonable. PRINCIPLES OF CONSOLIDATION. The Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries, after elimination of intercompany transactions and balances. The functional currency for the majority of the Company's subsidiaries is the U.S. dollar, and for such subsidiaries, foreign exchange gains and losses are included in net income and were not significant in any of the periods presented. For two subsidiaries, the functional currency is the local currency, and for these subsidiaries, remeasurement gains and losses are included in a separate component of stockholders' equity. Certain receivables from two subsidiaries have been classified as long term and the cumulative translation adjustments related to these receivables are presented as a separate component of stockholders' equity. CASH EQUIVALENTS. Cash and cash equivalents consist of highly liquid investments with a maturity date at acquisition of three months or less. Cash and cash equivalents are stated at cost, plus any accrued interest, which approximates market value. 17 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TEMPORARY INVESTMENTS. Temporary investments in debt and equity securities are classified as available for sale and measured at fair value. Material unrealized gains and losses, net of tax, are recorded as a separate component of stockholders' equity until realized. There were no significant differences between amortized cost and fair market value for investments, individually or in the aggregate, at either September 30, 1997 or 1998. Any gains or losses on sales of investments are computed by specific identification. No investments were sold in 1996, 1997 or 1998. INVENTORIES. Inventories are stated at the lower of cost (first-in, first-out) or market. PROPERTY AND EQUIPMENT. For financial reporting purposes, depreciation is computed on the straight-line method over the estimated useful lives of the assets. Estimated useful lives are as follows:
Years - ------------------------------------------------------------------------------- Land improvements 15 Buildings and improvements 40 Machinery and equipment 3 to 10 Furniture and fixtures 3 to 10 Leasehold improvements Lease term - -------------------------------------------------------------------------------
INTANGIBLE ASSETS. Intangible assets are amortized on a straight-line basis over their estimated lives as follows: goodwill, twenty-five years; purchased technology, six years. REVENUE RECOGNITION. The Company recognizes revenue when the buyer accepts and takes title to the equipment, generally upon shipment. Product warranty costs are accrued in the period that sales are recognized. During the second half of fiscal 1998, the Company recognized approximately $58,000,000 of net sales to two customers who accepted and took title to the related equipment, and agreed to normal payment terms, but requested that the Company store the equipment until predetermined shipment dates. At September 30, 1998, the Company was storing a total of $53,000,000 of such equipment with shipment dates ranging through July 1999. RESEARCH, DEVELOPMENT AND RELATED ENGINEERING. Research, development and related engineering costs are expensed as incurred. Funds received under certain development funding arrangements are recorded as a reduction to such expenses as earned. The Company's products include certain software applications that are integral to the operation of the product. The costs to develop such software have not been capitalized as the Company believes its current software development process is essentially completed concurrent with the establishment of technological feasibility of the software and/or development of the related hardware (See Note 13). NET INCOME (LOSS) PER SHARE. Effective October 1, 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share" (EPS), which requires a 18 7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS dual presentation of basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net income or loss by the weighted average common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if other dilutive potential common shares were exercised or converted into Common Stock. For fiscal 1998, net loss per share was calculated using only the weighted average number of common shares outstanding as the addition of potential common shares would have been anti-dilutive. For fiscal 1996 and 1997, the difference between the shares used in the computation of basic and diluted EPS results from the inclusion of stock warrants and stock options issued to employees under employee stock plans. EMPLOYEE STOCK PLANS. The Company accounts for its stock option and employee stock purchase plans in accordance with the provisions of the Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company continues to apply the provisions of APB No. 25 for purposes of determining net income or loss and has adopted the pro forma disclosure requirements of SFAS No. 123 effective October 1, 1996 (see Note 11). RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements; and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes annual and interim reporting standards for a Company's business segments and related disclosures about its products, services, geographic areas and major customers. Both SFAS No. 130 and SFAS No. 131 are effective for fiscal years beginning after December 15, 1997. The Company believes that the adoption of the new standards will not have a material effect on the financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for derivatives used for hedging activities. It requires that all derivatives be recognized either as an asset or liability, be measured at fair value and that the results of such measurement be included either in the income statement or in stockholders' equity, depending on the nature of the transaction. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. The Company believes that the application of SFAS No. 133 will not have a material effect on the Company's financial statements. RECLASSIFICATIONS. Certain reclassifications have been made to the prior years' Consolidated Financial Statements to conform to the fiscal 1998 presentation. FISCAL YEAR. The Company uses a 52-53 week fiscal year ending on the Friday closest to September 30. The accompanying financial statements have been shown as ending on September 30. Fiscal 1996 included 52 weeks, fiscal 1997 included 53 weeks and fiscal 1998 included 52 weeks. 19 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. TEMPORARY INVESTMENTS Temporary investments at September 30 are comprised of the following:
(in thousands) 1997 1998 - -------------------------------------------------------------------------- Municipal bonds $74,971 $25,425 Municipal notes 2,001 -- Auction rate preferreds -- 3,000 - -------------------------------------------------------------------------- Total $76,972 $28,425 - --------------------------------------------------------------------------
All of the Company's temporary investments at September 30, 1998, mature within one year. NOTE 3. BALANCE SHEET COMPONENTS
September 30 (in thousands) 1997 1998 - -------------------------------------------------------------------------- Inventories: Raw materials $ 92,660 $ 103,738 Work-in-process 128,662 103,362 Finished goods 7,131 5,875 - -------------------------------------------------------------------------- Total $ 228,453 $ 212,975 - -------------------------------------------------------------------------- Property and equipment: Land and improvements $ 11,494 $ 11,494 Buildings and improvements 45,470 74,822 Machinery and equipment 137,872 172,584 Furniture and fixtures 28,899 36,114 Leasehold improvements 24,360 24,220 - -------------------------------------------------------------------------- Total 248,095 319,234 Accumulated depreciation and amortization (97,110) (128,212) - -------------------------------------------------------------------------- Property and equipment, net $ 150,985 $ 191,022 - -------------------------------------------------------------------------- Intangible assets: Goodwill $ 6,019 $ 6,019 Purchased technology 1,000 1,000 - -------------------------------------------------------------------------- 7,019 7,019 Accumulated amortization (2,606) (3,283) - -------------------------------------------------------------------------- Total $ 4,413 $ 3,736 - -------------------------------------------------------------------------- Accrued liabilities: Compensation $ 30,917 $ 28,792 Product warranty 43,534 48,943 Customer deposits and advances 42,608 31,452 Restructuring and related charges -- 7,332 Other 10,390 14,013 - -------------------------------------------------------------------------- Total $ 127,449 $ 130,532 - --------------------------------------------------------------------------
20 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. RESTRUCTURING AND RELATED CHARGES During the fourth quarter of fiscal 1998, the Company recorded restructuring and related charges of $33,680,000. The charge includes costs of $28,521,000 resulting from the termination of the Company's previously announced 200-APS photoresist processing system (the "200-APS charge") and a provision of $5,159,000 for reductions in the Company's workforce that includes severance compensation and benefit costs for workforce reductions announced in July 1998 ($2,696,000) and September 1998 ($2,463,000). These workforce reductions were implemented in response to global weakness in the demand for semiconductor capital equipment as well as the decision to terminate the 200-APS product. The 200-APS charge consisted of: the write-off of 200-APS inventory and purchase commitments, which has been classified as cost of sales; the write-off of fixed assets that were employed in the 200-APS effort; costs to fulfill obligations to customers utilizing 200-APS systems, including the cancellation of certain receivables and the support of such systems through fiscal 2000; and certain other costs related to exiting the 200-APS program. Restructuring and related charges in fiscal 1998 (in thousands):
200-APS Inventory Severance and Purchase Fixed Customer Other Exit and Benefits Commitments Assets Obligations Costs Total - ----------------------------------------------------------------------------------------------------------------- Restructuring provision $ 5,159 $ 19,117 $ 3,213 $ 5,580 $ 611 $ 33,680 Incurred to date (2,153) (17,285) (3,213) (3,287) (410) (26,348) - ----------------------------------------------------------------------------------------------------------------- Balance at September 30, 1998 $ 3,006 $ 1,832 $ -- $ 2,293 $ 201 $ 7,332 - -----------------------------------------------------------------------------------------------------------------
The Company expects that during fiscal 1999 it will make cash payments of approximately $6,832,000 related to the restructuring, with the remaining $500,000 in cash payments to occur in fiscal 2000. Substantially all employee terminations will be effective July 1999. NOTE 5. SVG LITHOGRAPHY SYSTEMS, INC. Through March 17, 1997, the Company owned 94% of SVG Lithography Systems, Inc. (SVGL) and International Business Machines, Inc. (IBM) owned the remaining 6%. The minority interest reflected in the Consolidated Statement of Operations represented that share of SVGL's operating results which were attributable to IBM. On March 18, 1997, the Company purchased IBM's 6% interest in SVGL for $3,000,000. As a result, the Company now accounts for SVGL as a wholly-owned subsidiary. NOTE 6. SETTLEMENT OF ROYALTY OBLIGATION Under the terms of a research and development agreement, SVGL owed IBM certain royalties based on future operating results. On March 18, 1997, the Company satisfied this royalty obligation to IBM in exchange for $5,000,000 in cash, 489,296 shares of Common Stock valued at $10,000,000 and $23,000,000 in SVGL product. Of the $38,000,000 total, $32,582,000 related to products currently under development and was recognized as an expense in the second quarter of fiscal 1997, and $5,418,000 related to existing products and was recorded as a prepayment which is being amortized to expense through fiscal year 2000 in proportion to the related product sales. During fiscal 1996 the Company made royalty payments pertaining to this agreement of $2,370,000. 21 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7. DEBT ARRANGEMENTS On June 30, 1998, the Company entered into an unsecured $150,000,000 bank revolving line of credit agreement, which expires June 30, 2001. Advances under the line bear interest at the Prime Rate or 0.65% to 1.50% over LIBOR. The agreement includes covenants regarding liquidity, profitability, leverage, coverage of certain charges and minimum net worth and prohibits the payment of cash dividends. On October 23, 1998, certain of the covenants were amended, in part to allow for the Company's fourth quarter fiscal 1998 net loss. The Company is in compliance with the covenants as amended. In February 1997, the Company received a $6,500,000 loan from the Connecticut Development Authority. The loan has a ten year term, bears interest at 8.25%, is secured by the Company's Wilton, Connecticut facility which houses certain operations of SVGL and had a remaining principal balance of $5,791,000 at September 30, 1998. At September 30, 1998, TLI had outstanding, two loans and two special assessment bonds, which bear interest at rates between 8.5% and 12% with maturity dates through April 2007. At September 30, 1998, such instruments had an aggregate remaining principal balance of $714,000. Interest payments were $624,000 in 1996, $488,000 in 1997 and $655,000 in 1998. NOTE 8. EMPLOYEE BENEFIT PLANS The Company's profit-sharing plan provides quarterly distributions to eligible employees as determined by the Board of Directors. Profit-sharing distributions were $7,235,000 in 1996, $1,172,000 in 1997 and $1,623,000 in 1998. Under the Company's Cash or Deferred Profit Sharing Plan (401(k) Plan), the Company may make contributions, depending on the amount of the employee's contribution, up to a maximum of 3% of compensation. The Company's contributions were $2,999,000 in 1996, $3,135,000 in 1997 and $3,407,000 in 1998. In February 1997, the Company adopted a non-qualified deferred compensation plan that allows a select group of management or highly compensated Employees and Directors to defer a portion of their salary, bonus and other benefits. The plan is unfunded and amounts due participants represent general obligations of the Company. The Company may credit additional amounts to participants' account balances, depending on the amount of the employee's contribution, up to a maximum of 5% of an employee's annual salary and bonus. In addition, interest is credited to the participants' account balances at 120% of the average Moody's corporate bond rate. For 1998, participants' accounts will be credited at 8.71%. Company contributions and related interest become 100% vested five years after the plan year in which the contribution was made. During fiscal 1997 and fiscal 1998, the Company's expense was $609,000 and $878,000, respectively, and at September 30, 1998, the Company's liability under the deferred compensation plan was $3,573,000. Additionally, the Company assumed unfunded salary continuation agreements with certain key executives and employees of TLI. Under the terms of the agreement, the Company has agreed to pay certain fixed amounts over a ten year period after the employees reach the age of 65. Payments began vesting December 1990 and become fully vested only if the participants remain employed by the Company through the age of 65. The present value of these payments, 22 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS calculated using a discount rate of 6%, is being charged ratably to expense over the vesting period. During fiscal 1996, 1997, and 1998 the Company had related expenses of $17,000, $32,000, and $14,000, respectively, and at September 30, 1998, the Company's liability under these agreements was $625,000. At September 30, 1998, four officers of the Company had employment agreements that provide, in the event of disability, death, or termination meeting certain criteria, for severance payments based on a multiple of their then-current compensation. At September 30, 1998, the aggregate potential payments under these agreements would have been approximately $7,100,000. The Company also assumed the defined benefit pension plan of Tinsley Laboratories, Inc. The plan had previously been terminated during 1995 and the Company is currently in the process of finalizing the termination process. At both September 30, 1997 and September 30, 1998, the Company had recorded a minimum pension liability of $274,000 within stockholders' equity, net of income taxes, which is based upon the excess of the estimated accumulated benefit obligation of $1,705,000 and $1,604,000, respectively, over the fair market value of plan assets (primarily money market funds) of $1,431,000 and $1,330,000, respectively. Upon finalization of the plan termination, the minimum pension liability will be charged to the statement of operations. NOTE 9. INCOME TAXES The provision for income taxes consists of (in thousands):
Years Ended September 30, 1996 1997 1998 - ---------------------------------------------------------------------------- Current: Federal $ 32,735 $ (1,218) $ 478 State 6,090 1,433 1,252 Foreign 1,721 351 1,840 - ---------------------------------------------------------------------------- Total current 40,546 566 3,570 - ---------------------------------------------------------------------------- Deferred: Federal (4,928) (293) (14,720) State (634) 1,241 (2,430) - ---------------------------------------------------------------------------- Total Deferred (5,562) 948 (17,150) - ---------------------------------------------------------------------------- $ 34,984 $ 1,514 $(13,580) - ----------------------------------------------------------------------------
Domestic and foreign income before income taxes and minority interest is as follows (in thousands):
Years Ended September 30, 1996 1997 1998 - ---------------------------------------------------------------------------- Domestic $ 95,186 $ 3,898 $(30,925) Foreign 4,623 300 3,768 - ---------------------------------------------------------------------------- $ 99,809 $ 4,198 $(27,157) - ----------------------------------------------------------------------------
23 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effective tax rate differs from the Federal statutory rate as follows (in thousands):
Years Ended September 30, 1996 1997 1998 - ------------------------------------------------------------------------------------------------ Statutory rate $ 34,933 $ 1,469 $ (9,505) State taxes, net of Federal effect 3,297 200 (1,178) Foreign taxes at differing rates 197 268 (51) FSC commission (2,164) (464) (1,437) Change in valuation allowance (2,656) -- -- Tax exempt interest -- (2,284) (1,799) Settlement of royalty obligation -- 1,500 -- Other 1,377 825 390 - ------------------------------------------------------------------------------------------------ Total $ 34,984 $ 1,514 $(13,580) - ------------------------------------------------------------------------------------------------
The items giving rise to deferred taxes were as follows (in thousands):
September 30, 1997 1998 - ----------------------------------------------------------------------------------------------- Deferred tax assets: Reserves not recognized for tax purposes $ 11,757 $ 28,907 Net operating loss carryforwards of acquired companies 3,130 3,130 Accelerated depreciation 273 273 - ----------------------------------------------------------------------------------------------- Total deferred tax assets 15,160 32,310 Valuation allowance (9,297) (9,297) - ----------------------------------------------------------------------------------------------- Total $ 5,863 $ 23,013 - -----------------------------------------------------------------------------------------------
At September 30, 1998, approximately $7,900,000 of Federal loss carryforwards were available to offset future Federal taxable income generated by SVGL, through the year 2007, subject to certain limitations. The valuation allowance relates to the net deferred tax assets of SVGL. In 1996, 1997 and 1998, the Company made income tax payments of $36,059,000, $2,882,000 and $16,878,000, respectively. NOTE 10. STOCKHOLDERS' EQUITY COMMON STOCK WARRANTS. On September 30, 1994, as part of a series of agreements with SEMATECH, the Company sold warrants for $8,204,000 under which SEMATECH had the right to purchase 1,750,000 shares of Common Stock at $13.625 per share. The warrants were subject to a net exercise provision that permitted the holder to make a cashless exercise of the warrants based on the closing price of the Common Stock. In April 1996, SEMATECH exercised the warrants through the net issuance provision resulting in the issuance of 701,923 shares of Common Stock with no cash proceeds to the Company. 24 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS COMMON STOCK. In October 1995, the Company sold 4,025,000 shares of its Common Stock through an underwritten public offering. The net proceeds from the offering were approximately $126,200,000. PREFERRED SHARES PURCHASE RIGHTS. In September 1996, the Company's Board of Directors adopted a plan for the distribution of one Preferred Shares Purchase Right (the Rights) to the holder of each outstanding share of the Company's Common Stock. The rights expire in September 2006 and are not exercisable until a person or group announces the acquisition of 15% or more of the Company's outstanding Common Stock, or the commencement of a tender or exchange offer for 15% or more of the Company's Common Stock. Each Right entitles its holder to purchase 1/1000 of one new share of the Company's Series A Participating Preferred Stock at an exercise price of $125, subject to certain antidilution adjustments. Additionally, a holder would be entitled, under certain circumstances, to purchase shares of Common Stock of the Company or, in other cases, of the acquiring company, having a market value of twice the exercise price of the Right. Under certain conditions, the Company may redeem the Rights for a price of $0.01 per Right or exchange each Right not held by the acquirer for one share of the Company's Common Stock. NOTE 11. STOCK OPTION AND PURCHASE PLANS Under the Company's stock option plans, the Board of Directors may, at its discretion, grant incentive or nonqualified stock options to employees and directors, and options are automatically granted annually to directors who are not employees of the Company. Options may be granted for a period not to exceed ten years from the date of grant, at prices at least equal to the fair market value of Common Stock at the grant date, and become exercisable generally over a period of up to five years. Activity under the plans is as follows (shares in thousands):
Shares Weighted Average Under Option Exercise Price - ------------------------------------------------------------------------ Balances, September 30, 1995 1,766 $ 15.72 Granted 1,519 19.21 Exercised (115) 7.67 Canceled (1,043) 26.89 - ------------------------------------------------------------------------ Balances, September 30, 1996 2,127 13.02 Granted 823 25.03 Exercised (372) 10.34 Canceled (117) 17.94 - ------------------------------------------------------------------------ Balances, September 30, 1997 2,461 16.97 Granted 1,121 21.64 Exercised (158) 5.47 Canceled (218) 20.24 - ------------------------------------------------------------------------ Balances, September 30, 1998 3,206 $ 18.93 - ------------------------------------------------------------------------
25 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes information concerning options outstanding and exercisable as of September 30, 1998:
Options Outstanding Options Exercisable - -------------------------------------------------------------------------------------------------- Weighted Average Weighted Weighted Range of Number Contractual Life Average Number Average Exercise Prices Outstanding (in years) Exercise Price Exercisable Exercise Price - -------------------------------------------------------------------------------------------------- $ 4.66 - $ 7.50 234,238 .67 $ 6.61 231,602 $ 6.63 $10.50 - $15.00 512,818 3.86 $ 11.87 305,481 $ 10.81 $ 16.13 747,086 4.79 $ 16.13 348,941 $ 16.13 $16.63 - $20.63 676,027 8.77 $ 20.22 68,750 $ 19.00 $21.25 - $32.69 1,036,239 7.23 $ 26.38 180,199 $ 26.25 - ------------------------------------------------------------------------------------------------- Total 3,206,408 5.97 $ 18.93 1,134,973 $ 14.54 - -------------------------------------------------------------------------------------------------
At September 30, 1998, options to purchase 1,087,170 shares of Common Stock were available for future grant. There were 549,750 and 732,024 options exercisable as of September 30, 1996 and 1997, respectively with a weighted average exercise price of $8.29 and $10.16, respectively, per share. In July 1996, the Company repriced 940,114 employee options to purchase shares with exercise prices between $19.63 and $44.25 to a new exercise price of $16.13. In September 1996 the Company repriced 30,000 director options to purchase shares with exercise prices between $19.56 and $44.50 to an exercise price of $18.06. Vesting periods, for all such options, recommenced at the date of repricing. Under the Company's Employee Stock Purchase Plan, 2,200,000 shares of Common Stock were reserved for issuance of which 1,495,730 had been issued at September 30, 1998. The plan permits virtually all employees to purchase, through payroll deductions, Common Stock at 85% of the lower of the fair market value of the Common Stock on the first or last day of the offering period. The plan has offering periods of twelve months, with a new twelve-month period beginning each April 1 and October 1. Pro forma net income and earnings per share. The Company has elected to follow APB Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its employee stock options. Under APB No. 25, because the exercise price of the Company's employee options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company's financial statements. Pro forma information regarding net income and earnings per share is required by SFAS No. 123. This information is required to be determined as if the Company had accounted for its employee stock options (including shares under the Employee Stock Purchase Plan) granted subsequent to September 30, 1995 under the fair value method of that statement. The fair value of options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for fiscal 1996, 1997 and 1998, respectively: risk free rates of 6.3%, 6.4% and 6.0%; a stock price volatility factor of 56%, 56% and 64%; an expected option life of 2 years, 2 years and 7.2 months following vesting 26 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for Officer and Directors and 9 months, 9 months and 7.3 months for all others; and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and recognition of forfeitures as they occur. The weighted average fair value of options granted during the fiscal 1996, 1997 and 1998 was approximately $7.79, $12.57 and $9.85 per share, respectively. The fair value of the employee purchase rights under the Employee Stock Purchase Plan was estimated using the same model, but with the following weighted average assumptions for fiscal 1996, 1997 and 1998, respectively: risk-free rates of 5.5%, 5.8% and 6.0%, stock price volatility factor of 56%, 56% and 60%, and expected option life of one year. The weighted average fair value of purchase rights granted in fiscal 1996, 1997 and 1998 was approximately $9.26, $8.76 and $7.68 per share, respectively. For purposes of pro forma disclosures required by SFAS 123, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information):
1996 1997 1998 - ---------------------------------------------------------------------------------- Proforma net income (loss) $61,960 $(3,738) $(21,116) Proforma earnings (loss) per share--basic $ 2.02 $ (.12) $ (.65) Proforma earnings (loss) per share--diluted $ 1.99 $ (.12) $ (.65) - -----------------------------------------------------------------------------------
For pro forma purposes in accordance with SFAS No. 123, the repricing of employee stock options during 1996 is treated as a modification of the stock-based award, with the original options being repurchased and new options granted. Any additional compensation arising from the modification is recognized over the remaining vesting period of the new grant. SFAS 123 is effective for stock-based awards granted by the Company commencing October 1, 1995. All stock-based awards granted before October 1, 1995, have not been valued and no pro forma compensation expense has been recognized. However, any option granted before October 1, 1995 that was repriced in 1996 is treated as a new grant within 1996 and valued accordingly. In addition, because compensation expense is recognized over the vesting period of the option, the initial impact on pro forma income may not be representative of pro forma compensation expense in future years. NOTE 12.COMMITMENTS Future minimum lease payments for operating leases for the years ended September 30 (primarily facilities) are as follows (in thousands): 1999 $ 5,128 2000 3,882 2001 3,337 2002 3,291 2003 3,177 Thereafter through 2010 3,970 - ------------------------------------------------------------------- Total $22,785 - -------------------------------------------------------------------
Rent expense was $9,024,000, $7,009,000 and $7,006,000 in 1996, 1997 and 1998, respectively. 27 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has an option to purchase the land and buildings at one of their track facilities for approximately $10,000,000, which expires, on or about, December 11, 1998. The Company is in the process of determining whether they will execute this option or extend their current operating lease. NOTE 13. RESEARCH AND DEVELOPMENT AGREEMENTS The Company, primarily through SVGL, has obtained research and development funding agreements with outside parties under which the Company receives payments based on meeting specified product development milestones. The Company does not anticipate that such funding will cover the entire cost of the development efforts to which it pertains. Therefore, it is recorded as a reduction of research, development, and related engineering, in amounts approximating the percentage of costs incurred to date to the total estimated costs of such development efforts. The Company incurred costs of $30,288,000 in 1996, $40,227,000 in 1997 and $12,842,000 in 1998 relating to such product development and recognized $4,994,000, $7,968,000 and $11,997,000, respectively, in related funding. During fiscal 1996, the Company entered into agreements with certain customers (the Participants) whereby each agreed to assist in funding the Company's development of an advanced technology 193-nanometer Micrascan system. In exchange for such funding the Participants receive the right to purchase one such system and in addition, receive a right of first refusal (ratable among such participants) to all such machines manufactured during the first two years following the initial system shipments. For each initial system ordered, each Participant agreed to fund $5,000,000 in such development costs. The agreements call for each Participant to pay $1,000,000 of initial development funding and four subsequent payments of $1,000,000 upon the completion of certain development milestones. The participants may withdraw from the development program without penalty but payments made against completed development milestones are not refundable and all preferential rights to future equipment are forfeited. As of September 30, 1998, the Company had received $20,000,000 in funding from six Participants, of which $19,765,000 had been recognized and offset against research and development expenditures. The agreements with the Participants stipulate that if the Company receives funding for the development program in excess of $25,000,000, it will issue, ratably to the Participants, credits totaling such excess in the form of a cash discount which can be applied to the purchase of additional systems by each Participant. NOTE 14. GEOGRAPHIC SEGMENTS The Company's products are manufactured in the United States and are sold worldwide. The Company markets internationally through both its foreign-based sales and service operations and through outside distributors and sales representatives. One customer accounted for 30% of sales in 1996, 36% of sales in 1997, and 40% of sales in 1998; a second customer accounted for 7% of sales in 1996, 22% of sales in 1997 and 17% of sales in 1998; and a third customer accounted for 10% of sales in 1996, 6% of sales in 1997 and 13% of sales in 1998. 28 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents a summary of operations by geographic region. Inter-region transfers and eliminations represent transfers between domestic operations and international subsidiaries. Transfers and commission arrangements between geographic areas are at prices sufficient to recover a reasonable profit. Research, development and related engineering expenses and general corporate expenses are included in operating income from North American operations.
September 30 (in thousands) 1996 1997 1998 - ----------------------------------------------------------------------------------- Net Sales: North America: Unaffiliated customers: North America $431,571 $442,422 $393,579 Europe 131,570 87,312 163,482 Far East 50,340 53,287 12,810 Other 203 126 96 Inter-region transfers 29,004 26,264 28,156 Europe 27,629 21,044 28,958 Far East 16,024 10,035 9,700 Eliminations (29,004) (26,264) (28,156) - -------------------------------------------------------------------------------------- Consolidated net sales $657,337 $614,226 $608,625 - -------------------------------------------------------------------------------------- Operating Income (Loss): North America $ 82,941 $ (2,414) (34,309) Europe 3,964 (1,718) 3,630 Far East 1,241 591 79 Eliminations (1,085) (1,882) (1,621) - -------------------------------------------------------------------------------------- Consolidated operating income (loss) $ 87,061 $ (5,423) $(32,221) - -------------------------------------------------------------------------------------- Identifiable Assets: North America $707,023 $731,158 $701,129 Europe 37,934 28,361 38,883 Far East 8,351 6,827 10,213 Eliminations (9,051) (10,329) (19,635) - -------------------------------------------------------------------------------------- Consolidated assets $744,257 $756,017 $730,590 - --------------------------------------------------------------------------------------
NOTE 15. ACQUISITION OF TINSLEY LABORATORIES, INC. On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. in a stock for stock transaction whereby approximately 1,091,000 shares of the Company's Common Stock were exchanged for all outstanding shares of TLI Common Stock. TLI designs, manufacturers and sells precision optical components, assemblies and systems to customers in a variety of industries and research endeavors. The transaction was accounted for as a pooling of interests for financial reporting purposes. All prior periods have been restated to include TLI financial results. 29 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Prior to the merger, TLI used a calendar year end. The Company's restated financial statements combine the fiscal 1996 results of the Company with the calendar 1996 results of TLI. Both companies have been accounted for on a September fiscal year for 1997 and 1998. TLI's results of operations for the quarter ended December 31, 1996, that are not material to the consolidated companies, have been included in the combined financial statements for both fiscal 1996 and fiscal 1997, with the adjustment to conform the fiscal periods reflected as an adjustment to retained earnings in the first quarter of fiscal 1997. The following table illustrates the combination of TLI and the Company for periods prior to the effective date of the merger:
(In thousands) 1996 1997 - ---------------------------------------------------- Net Sales: Silicon Valley Group $639,928 $594,957 TLI 17,409 19,269 - ---------------------------------------------------- Combined net sales $657,337 $614,226 - ---------------------------------------------------- Net Income: Silicon Valley Group $ 63,221 $ 1,487 TLI 878 1,105 - ---------------------------------------------------- Combined net income $ 64,099 $ 2,592 - ----------------------------------------------------
NOTE 16. SUMMARIZED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
First Second Third Fourth (in thousands, except per share amounts) Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------ 1998 Net sales $ 188,707 $ 195,872 $ 116,385 $ 107,661 Gross profit 74,388 77,514 38,088 10,239 Income (loss) before income taxes 17,860 14,059 (11,357) (47,719) Net income (loss) 12,145 9,560 (6,817) (28,465) Net income (loss) per share--basic 0.38 0.30 (0.21) (0.87) Net income (loss) per share--diluted 0.37 0.29 (0.21) (0.87) 1997 Net sales $ 128,022 $ 145,881 $ 166,079 $ 174,244 Gross profit 48,754 54,554 62,746 70,058 Income (loss) before income taxes and minority interest 5,661 (24,294) 10,012 12,819 Net income (loss) 3,584 (15,982) 6,562 8,428 Net income (loss) per share--basic 0.11 (0.51) 0.21 0.26 Net income (loss) per share--diluted 0.11 (0.51) 0.20 0.25 - ------------------------------------------------------------------------------------------------------
30 19 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Silicon Valley Group, Inc.: We have audited the accompanying consolidated balance sheets of Silicon Valley Group, Inc. and its subsidiaries as of September 30, 1997 and 1998, and the related consolidated statements of operations, Stockholders' equity and cash flows for each of the three years in the period ended September 30, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Silicon Valley Group, Inc. and its subsidiaries at September 30, 1997 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP [DELOITTE & TOUCHE LLP LOGO] San Jose, California October 26, 1998 31 20 FINANCIAL INFORMATION FIVE-YEAR SELECTED FINANCIAL DATA
Years Ended September 30, (in thousands, except per share amounts) 1994 1995 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------ Income Statement Data: Net sales $ 332,891 $ 475,141 $ 657,337 $ 614,226 $ 608,625 Income (loss) before income taxes and minority interest 27,411 61,696 99,809 4,198 (27,157) Net income (loss) 17,110 39,263 64,099 2,592 (13,577) Preferred stock dividend 1,190 537 -- -- -- Net income (loss) per share--basic $ .90 $ 1.66 $ 2.09 $ 0.08 $ (0.42) Shares used in per share computations--basic 19,113 23,627 30,657 31,635 32,438 Net income (loss) per share--diluted $ .87 $ 1.61 $ 2.06 $ 0.08 $ (0.42) Shares used in per share computations--diluted 19,587 24,326 31,122 32,414 32,438 Balance Sheet Data: Working capital $ 174,509 $ 328,128 $ 466,637 $ 420,486 $ 371,960 Total assets 284,515 513,665 744,257 756,017 730,590 Long-term debt and capital leases 3,418 2,015 1,718 6,515 5,865 Stockholders' equity 193,363 358,614 551,242 573,110 561,530 Other Data: Backlog $ 213,121 $ 400,324 $ 404,889 $ 437,668 $ 254,130 Number of employees 1,999 2,757 3,185 3,515 2,660 - ------------------------------------------------------------------------------------------------------------------------
Common Stock Prices The Company's Common Stock is traded in the over-the-counter market on the Nasdaq National Market System under the symbol SVGI. The following table sets forth the range of high and low sales prices of the stock during fiscal 1997 and fiscal 1998 as reported by Nasdaq-NMS.
Fiscal 1997 Fiscal 1998 - -------------------------------------------------------------------------------------- High Low High Low - -------------------------------------------------------------------------------------- First Quarter $19-3/8 $15-3/8 $36-1/4 $18-3/8 Second Quarter 27-1/8 18-5/8 27-7/8 19 Third Quarter 26-3/8 18-1/2 21-1/2 15-3/4 Fourth Quarter 37-3/4 28-1/2 16-1/2 8 - --------------------------------------------------------------------------------------
To date, the Company has not declared or paid dividends on its Common Stock. The Board of Directors of the Company presently intends to retain all earnings for use in the Company's business and therefore does not anticipate declaring or paying any cash dividends in the foreseeable future. The Company's revolving credit facility prohibits the payment of cash dividends on Common Stock. As of November 27, 1998, there were 1,269 holders of record of the Common Stock. 32 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in this discussion 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, as amended. Such statements are subject to certain risks and uncertainties, including those discussed below, that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Forward-looking statements are indicated by an asterisk (*) following the sentence in which such statement is made. The Company undertakes no obligation to publicly release the results of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS The Company designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits. The Company's products are used in photolithography for exposure and photoresist processing, and in deposition for oxidation/diffusion and low pressure chemical vapor deposition ("LPCVD"). The Company manufactures and markets photolithography exposure SVGL products, photoresist processing Track products, oxidation/diffusion and LPCVD Thermco products and certain Tinsley precision optical components. On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. ("TLI"). (See "Liquidity and Capital Resources") The transaction has been accounted for as a pooling of interests for financial reporting purposes. All amounts discussed below have been retroactively restated to reflect the inclusion of TLI. The semiconductor industry into which the Company sells its products is highly cyclical and historically experienced periodic downturns that have had a severe effect on the semiconductor industry's demand for semiconductor processing equipment. As a result of the Asian economic crisis, an oversupply of certain semiconductor products, the impact of low cost personal computers, and various other factors, semiconductor manufacturers have reduced planned expenditures and cancelled or delayed the construction of new fabrication facilities. This slowdown in demand began to impact the Company during the fourth quarter of calendar 1997 (the Company's first fiscal quarter of 1998) as the Company experienced lower customer bookings ("bookings"), customer deferrals of scheduled equipment delivery dates and, to a lesser extent, customer order cancellations. For the four quarters of fiscal 1998 bookings were $137,253,000, $100,442,000, $123,641,000 and $65,936,000, respectively. By comparison, during the fourth quarter of fiscal 1997, the Company recorded bookings of $214,987,000. As a result of such lower bookings, order rescheduling and order cancellations, sales during the second half of fiscal 1998 were 42% below sales during the preceding six months. Further, the Company believes that sales during the first half of fiscal 1999 could be 10% to 15% lower than sales during the second half of fiscal 1998, partly as a result of these lower bookings.* A decrease in sales of this magnitude could result in further reductions in the Company's gross margin and net income in the first half of fiscal 1999.* There can be no assurance that the Company will not experience further customer delivery deferrals, additional order cancellations or a prolonged period of customer orders at reduced levels, any or a combination of which would have a material adverse effect on the Company's business and results of operations.* 33 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In an effort to lessen the impact of these lower sales volumes, the Company took several steps to reduce operating expenses, including a reduction in workforce, temporary shutdowns and the restructuring of certain portions of the Company's business. During the third quarter of fiscal 1998, the Company reduced its workforce by approximately 200 employees and shut down the majority of its operations for five days. During the fourth quarter of fiscal 1998, the Company shut down the majority of its operations for ten additional days and recorded restructuring and related charges of $33,680,000. The restructuring and related charges include costs of $28,521,000 resulting from the termination of the Company's previously announced 200-APS photoresist processing system (the "200-APS charge") and a provision of $5,159,000 for the July and September 1998 announced reductions in the Company's workforce for approximately 950 employees. The severance compensation and benefit costs for July 1998 were $2,696,000 for approximately 660 employees and the September 1998 charge was $2,463,000 for approximately 290 employees. The 200-APS charge consisted of the following components: (i) the write-off of 200-APS inventory totaling $19,117,000; (ii) the write-off of fixed assets with a net book value of $3,213,000 that were employed in the 200-APS effort; (iii) costs totaling $5,580,000 to fulfill obligations to customers committed to utilizing 200-APS systems, including the cancellation of certain receivables and the support of such systems through fiscal 2000; and (iv) certain other costs totaling $611,000 related to exiting the 200-APS program. The cost of the 200-APS inventory write-off was classified as cost of sales and the remaining restructuring costs were classified in operating expenses as restructuring and related charges. Historically, the Company has relied on a limited number of customers for a substantial percentage of its net sales. In fiscal 1998, the Company's three largest customers accounted for 40%, 17% and 13% of net sales. The Company believes that, for the foreseeable future, it will continue to rely on a limited number of major customers for a substantial percentage of its net sales.* As a result of delays in delivering initial quantities of the subsequently terminated 200-APS Track product, one of the Company's largest Track customers has decided to purchase systems with similar capabilities from another supplier, which the Company expects will have an adverse effect on Track's sales in future periods.* (See "Risks Inherent in the Company's Business--Rapid Technological Change; Dependence on New Product Development"). The loss of any other significant customer, further delays in shipments due to rescheduling or additional reductions in orders by a significant customer, including reductions in orders due to market, economic or competitive conditions in the semiconductor industry, will further exacerbate the adverse effect the customer order rescheduling and cancellations discussed above have had on the Company's business and results of operations.* FISCAL 1998 COMPARED TO FISCAL 1997 For fiscal 1998, net sales were $608,625,000, slightly below fiscal 1997 net sales of $614,226,000. The decrease in net sales was due to lower shipments of Thermco and Track products during fiscal 1998, offset in part by increased shipments of the SVGL Micrascan photolithography product. The Company's fiscal 1998 bookings were $427,272,000 (which represented a book to bill ratio of 0.70 to 1), significantly below fiscal 1997 bookings of $648,001,000 (which represented a book to bill ratio of 1.05 to 1). At September 30, 1998, the Company had a backlog of $254,130,000, a 42% decrease from the September 30, 1997 backlog of $437,668,000. The Company includes in backlog only those orders to which a purchase order number has been assigned by the customer, with substantially all of the terms and conditions agreed upon, and for which delivery has been specified within twelve months. At September 30, 1998, the 34 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS backlog included orders for 34 Micrascan photolithography products. In addition to the products included in backlog, the Company had 19 orders for SVGL Micrascan photolithography products with scheduled delivery dates outside the twelve-month backlog window. During the second half of fiscal 1998, the Company recognized approximately $58,000,000 of net sales to two customers who accepted and took title to the related equipment, and agreed to normal payment terms, but requested that the Company store the equipment until predetermined shipment dates. At September 30, 1998, the Company was storing a total of $53,000,000 of such equipment with shipment dates ranging through July 1999. For fiscal 1998, the Company's gross margin was 33%, significantly below the fiscal 1997 gross margin of 38%. As discussed above, $19,117,000 of the fiscal 1998 restructuring charge for the write-off of 200-APS inventory has been included in cost of sales. This restructuring charge accounted for 3% of the year to year decrease in gross margin. Without taking into account the 200-APS inventory charge, the fiscal 1998 gross margin was 36%, a decrease of 2% from the fiscal 1997 gross margin. This decrease was primarily the result of lower volumes and higher fixed costs for SVGL products during the second half of fiscal 1998 and the overall effect of lower volumes of Thermco and to a lesser degree, Track products. Research, development and related engineering ("R&D") expenses are net of funding received from outside parties under various development agreements. Such funding is typically payable upon the attainment of one or more development milestones that are specified in the agreement. Neither the spending, nor the recognition of the funding related to the development milestones is ratable over the term of the agreements. During fiscal 1996, the majority of development funding was received by SVGL from the industry consortium of semiconductor manufacturers, SEMATECH. In fiscal 1997 and fiscal 1998, the funding was primarily related to agreements between the Company and certain customers for the development of a 193 nanometer Micrascan system. (See "SVGL--Research and Development Funding.") R&D expenses were $87,272,000 (14% of net sales) during fiscal 1998, compared to $74,311,000 (12% of net sales) during fiscal 1997. Such R&D amounts are net of funding recognized under joint development agreements of $11,997,000 and $7,968,000 during fiscal 1998 and fiscal 1997, respectively. The year to year increase in R&D was primarily due to new product and process development, particularly for SVGL products, the design and development of equipment capable of processing the next generation 300mm wafer and costs associated with Track's subsequently terminated 200-APS program. During late fiscal 1996 and early fiscal 1997, the Company sold approximately $20,000,000 in product to SubMicron Technology PCL ("SMT"), a newly established semiconductor foundry in Thailand. SMT paid the Company approximately $14,000,000 before encountering severe financial difficulties. During the third quarter of fiscal 1997, the Company determined that the remaining receivable from SMT was uncollectible. After reversing costs accrued for the installation and warranty of the products sold to SMT, the Company recorded a net charge against its fiscal 1997 operating results of approximately $4,000,000 (the "SMT Charge"). During fiscal 1998, marketing, general and administrative ("MG&A") expenses were $130,615,000 (21% of net sales), lower than fiscal 1997 MG&A of $134,642,000 (22% of net sales). The decrease in MG&A from the preceding year was primarily due to the effect of the SMT Charge on fiscal 1997 MG&A. 35 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As discussed above, during the fourth quarter of fiscal 1998, the Company recorded restructuring and related charges of $33,680,000, of which $14,563,000 was classified as operating expenses. Under the terms of a research and development agreement, SVGL owed IBM certain royalties based on future operating results. During the second quarter of fiscal 1997, the Company satisfied its obligation to IBM. See the discussion of the IBM royalties in the comparison of fiscal 1997 to fiscal 1996 below. For fiscal 1998, the Company had an operating loss of $32,221,000, compared to an operating loss of $5,423,000 during fiscal 1997. In comparison to the preceding year, the fiscal 1998 operating loss was the result of the restructuring charges, lower gross margins on lower net sales and increased R&D expenses, offset in part by the non-recurring royalty settlement during fiscal 1997. Interest and other income was $6,082,000 during fiscal 1998 compared to $10,639,000 for fiscal 1997. The year to year decrease in interest and other income was primarily the result of lower interest income due to lower average cash balances available for investment, foreign currency translation and exchange losses, in large part due to the strength of the U.S. dollar during fiscal 1998, and the absence of certain royalty income under an agreement which expired during the fourth quarter of fiscal 1997. Interest expense of $1,018,000 in fiscal 1998 was equivalent to fiscal 1997 interest expense of $1,018,000. Interest expense in fiscal 1998 and 1997 was primarily associated with a $6,500,000 loan received from the Connecticut Development Authority. (See Note 7 to the Consolidated Financial Statements). The Company recorded a 50% benefit for income taxes for fiscal 1998, compared to a 36% provision for fiscal 1997. Variations in the Company's effective tax rate relate primarily to changes in the geographic distribution of its pretax income and certain tax-free interest income. (See Note 9 to the Consolidated Financial Statements). The minority interest reflected in the Company's 1997 financial statements represents that share of SVGL's operating results attributable at the time to its minority stockholder, IBM. In March 1997, the Company purchased IBM's interest in SVGL for $3,000,000. The Company now accounts for SVGL as a wholly owned subsidiary. For fiscal 1998 the Company had a net loss of $13,577,000 ($0.42 loss per share--diluted), compared to net income of $2,592,000 ($0.08 per share--diluted) for fiscal 1997. FISCAL 1997 COMPARED TO FISCAL 1996 For fiscal 1997, net sales were $614,226,000, a decrease of 7% from net sales of $657,337,000 during fiscal 1996. The lower net sales were the result of lower shipments of Thermco and Track products during fiscal 1997, offset in part by increased shipments of SVGL's Micrascan photolithography products, particularly revenues from shipments of Micrascan III that began shipping in the first quarter of fiscal 1997. The Company's fiscal 1997 bookings were $648,001,000 (which represented a book to bill ratio of 1.05 to 1), up slightly from fiscal 1996 bookings of $661,902,000 (which represented a book to bill ratio of 1.01 to 1). At September 30, 1997, the Company had a backlog of $437,668,000, an 8% increase over the September 30, 1996 backlog of $404,889,000. 36 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS As of September 30, 1997, the Company had recognized net sales of approximately $11,100,000 from two customers who accepted and took title to the related equipment and agreed to normal credit payment terms, but requested that the Company store the equipment until predetermined shipment dates. For fiscal 1997, the Company's gross margin was 38%, significantly below the fiscal 1996 gross margin of 42%. The decrease was primarily due to costs associated with Track's subsequently terminated 200-APS product and reduced shipments and manufacturing volumes of Thermco and Track products. The lower Thermco and Track margins were offset in part by increased fiscal 1997 SVGL gross margins, primarily due to the mix of Micrascan photolithography products shipped, and increased manufacturing volumes and efficiencies related to Micrascan products. R&D expenses were $74,311,000 (12% of net sales) during fiscal 1997, compared to $67,323,000 (10% of net sales) during fiscal 1996. Such R&D amounts are net of funding recognized under joint development agreements of $7,968,000 and $4,994,000 during fiscal 1997 and fiscal 1996, respectively. The increase in fiscal 1997 R&D was primarily due to multiple lithography development programs, efforts in all of the product groups to design equipment capable of processing the next generation 300mm wafers and Track's subsequently terminated 200-APS program. During fiscal 1997, MG&A expenses, which included the SMT Charge discussed above, were $134,642,000 (22% of net sales), significantly above fiscal 1996 MG&A of $119,238,000 (18% of net sales). In addition to the SMT Charge, the year to year increase in MG&A was due in part to the expansion of the Company's sales and marketing functions, increased personnel and operating expenditures related to SVGL's technical customer training, support and administrative functions, and the amortization of certain prepaid royalties related to a transaction with IBM which is discussed below. Additionally, increases in certain costs related to SVGL's higher fiscal 1997 shipping levels were offset by year to year reductions in similar costs for Track and Thermco products as a result of lower fiscal 1997 shipments. In comparison to the preceding fiscal year, MG&A was higher in fiscal 1997 as a percentage of net sales due to the combined effect of increased expenditures and lower net sales during fiscal 1997. Under the terms of a research and development agreement, SVGL owed IBM certain royalties based on future operating results. During the second quarter of fiscal 1997, the Company satisfied its obligation, recognized an expense of $32,582,000, which represented royalties related to products currently under development, and recorded a prepayment of $5,418,000, which represented royalties related to existing products which are being amortized through fiscal 2000, in proportion to the related product sales. For fiscal 1997, the Company had an operating loss of $5,423,000, compared to operating income of $87,061,000 during fiscal 1996. In comparison to the preceding year, the fiscal 1997 operating loss was the result of lower gross margins on lower net sales, higher operating expenses and the royalty settlement with IBM discussed above. Interest and other income was $10,639,000 during fiscal 1997 compared to $13,504,000 for fiscal 1996. Compared to the preceding fiscal year, the decrease in fiscal 1997 interest and other income was primarily the result of a significantly greater percentage of the Company's investment portfolio consisting of tax-free and tax-advantaged instruments, which have lower pre-tax yields than taxable instruments, and lower cash balances available for investment. The 37 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Company invests in tax-free and tax-advantaged instruments when the after-tax yields on such instruments exceed those on taxable instruments. Interest expense was $1,018,000 in fiscal 1997, an increase over fiscal 1996 interest expense of $756,000. The increased fiscal 1997 expense was primarily the result of interest paid on a $6,500,000 loan received from the Connecticut Development Authority in February 1997. The Company recorded a 36% provision for income taxes for fiscal 1997, compared to a 35% provision for fiscal 1996. Variations in the Company's effective tax rate relate primarily to changes in the geographic distribution of its pretax income. (See Note 9 to the Consolidated Financial Statements.) The minority interest reflected in the Company's financial statements represents that share of SVGL's operating results that were attributable at the time to its minority stockholder, IBM. In March 1997, the Company purchased IBM's interest in SVGL for $3,000,000. The Company now accounts for SVGL as a wholly-owned subsidiary and there is no longer a minority interest. In fiscal 1997, minority interest was recorded from the beginning of the fiscal year through the date the Company purchased IBM's interest and represented a reduction from income of $92,000. For fiscal 1996, minority interest represented a $726,000 reduction from income. Net income for fiscal 1997 was $2,592,000 ($0.08 per share--diluted), compared to net income of $64,099,000 ($2.06 per share--diluted) for fiscal 1996. RISKS INHERENT IN THE COMPANY'S BUSINESS FLUCTUATIONS IN QUARTERLY RESULTS. The Company has, at times during its existence, experienced quarterly fluctuations in its operating results. Due to the relatively small number of systems sold during each fiscal quarter and the relatively high revenue per system, customer order rescheduling or cancellations, or production or shipping delays can significantly affect quarterly revenues and profitability. The Company has experienced, and may again experience, quarters during which a substantial portion of the Company's net sales are realized near the end of the quarter.* Accordingly, shipments scheduled near the end of a quarter, which are delayed for any reason, can cause quarterly net sales to fall short of anticipated levels. Since most of the Company's expenses are fixed in the short term, such shortfalls in net sales could have an adverse effect on the Company's business and results of operations.* The Company's operating results may also vary from quarter to quarter based upon numerous factors including the timing of new product introductions, product mix, level of sales, the relative proportion of domestic and international sales, activities of competitors, acquisitions, international events, currency exchange fluctuations, and difficulties obtaining materials or components on a timely basis.* In light of these factors, the Company may again experience variability in its quarterly operating results.* RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCT DEVELOPMENT. Semiconductor manufacturing equipment and processes are subject to rapid technological change. The Company believes that its future success will depend upon its ability to continue to enhance its existing products and their process capabilities and to develop and manufacture new products with improved process capabilities that enable semiconductor manufacturers to fabricate semiconductors more efficiently.* The Company is developing Track and Lithography products, and has shipped limited quantities of Thermco products, capable of processing 300mm wafers in anticipation of the industry's transition to this larger wafer standard. Failure to successfully introduce these or any other new products in a timely manner could result in 38 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS the loss of competitive position and could reduce sales of existing products.* In addition, new product introductions could contribute to quarterly fluctuations in operating results as orders for new products commence and increase the potential for a decline in orders of existing products, particularly if new products are delayed.* From time-to-time, the Company has experienced delays in the introduction of its products and product enhancements due to technical, manufacturing and other difficulties and may experience similar delays in the future.* For example, during fiscal 1996, the Company announced the subsequently terminated 200-APS Track product. Initial shipments of the 200-APS were scheduled to commence during the second quarter of fiscal 1997, and were delayed until the second quarter of fiscal 1998. This delay, as well as industry developments, caused the Company to implement a plan, which was announced on September 30, 1998, to terminate future development and shipments of its 200-APS products, and to concentrate its efforts on completing a new product which has been in development for approximately one year. There can be no assurance that the Company will not experience delays in development or manufacturing problems related to its new product as a result of instability of the design of either the hardware or software elements of the new technology, or be able to efficiently manufacture the new product or other products.* These issues could result in product delivery delays and a subsequent loss of future sales.* Semiconductor manufacturers tend to select either a single supplier or a primary supplier for a certain type of equipment. The Company believes that prolonged delays in delivering initial quantities of newly developed products to multiple customers, whether due to the protracted release of product from engineering into manufacturing or due to manufacturing difficulties, could result in semiconductor manufacturers electing to install competitive equipment in their fabrication facilities and could preclude industry acceptance of the Company's products.* For example, the Company's largest Track customer has decided to secure deliveries from another source, a decision the Company believes is primarily due to the delay and subsequent termination of the 200-APS. The release into the market of a new technology Track product will not be accomplished for a number of quarters.* As a result, competitors will increase their market share, and it will be increasingly difficult for the Company to regain market position.* The Company's inability to effect the timely production of new products or any failure of these products to achieve market acceptance could have a material adverse effect on the Company's business and results of operations.* Historically, the unit cost of the Company's products has been the highest when they are newly introduced into production and cost reductions have come over time through engineering improvements, economies of scale and improvements in the manufacturing process.* As a result, new products have, at times, had an unfavorable impact on the Company's gross margins and results of operations. There can be no assurance that the initial shipments of new products will not have an adverse effect on the Company's profitability or that the Company will be able to attain design improvements, manufacturing efficiencies or manufacturing process improvements over time.* Further, the potential unfavorable effect of newly introduced products on profitability can be exacerbated when there is intense price competition in the marketplace.* COMPETITION. The semiconductor equipment industry is intensely competitive. The Company faces substantial competition both in the United States and other countries in all of its products. Significant competitive factors include technology and cost of ownership, a formula which includes such data as initial price, system throughput and reliability and time to maintain or repair. Other competitive factors include familiarity with particular manufacturers' products, established relationships between suppliers and customers, product availability 39 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and technological differentiation. Occasionally, the Company has encountered intense price competition with respect to particular orders and has had difficulty establishing new relationships with certain customers who have long-standing relationships with other suppliers. Many of the Company's competitors are Japanese corporations. As a result of the strength of the U.S. dollar in relation to the Japanese yen, the Company is at a disadvantage when competing on the basis of price. In light of the recent economic downturn in certain Asian countries which represent significant markets for such competitors, the Company believes that it may encounter more severe price competition in its non-Asian markets.* To compete effectively in these markets, the Company may be forced to reduce prices, which could cause further reduction in net sales and gross margins and, consequently, have a material adverse effect on the Company's financial condition and results of operations.* IMPORTANCE OF THE JAPANESE AND PACIFIC RIM MARKETS. The Company's customers are heavily concentrated in the United States and Europe. The Japanese and Pacific Rim markets (including fabrication plants located in other parts of the world which are operated by Japanese and Pacific Rim semiconductor manufacturers) represent a substantial portion of the overall market for semiconductor manufacturing equipment. To date, neither the Company's shipments into Japan nor the Pacific Rim have been significant. The Company believes that the Japanese companies with which it competes have a competitive advantage because their dominance of the Japanese and Pacific Rim semiconductor equipment market provides them with the sales and technology base to compete more effectively throughout the rest of the world. The Company is not engaged in any significant collaborative effort with any Japanese or Pacific Rim semiconductor manufacturers. As a result, the Company may be at a competitive disadvantage to the Japanese equipment suppliers which are engaged in such collaborative efforts with Japanese and Pacific Rim semiconductor manufacturers. The Company believes that it must substantially increase its share of these markets if it is to compete as a global supplier.* Further, in many instances, Japanese and Pacific Rim semiconductor manufacturers fabricate devices such as dynamic random access memory devices ("DRAMs"), with potentially different economic cycles than those affecting the sales of devices manufactured by the majority of the Company's U.S. and European customers. Failure to secure customers in these markets may limit the global market share available to the Company and may increase the Company's vulnerability to industry or geographic downturns.* Recent economic difficulties in certain Asian countries, particularly Korea, as well as the current extended downturn in demand for semiconductor manufacturing equipment, will adversely affect the Company's ability to penetrate such markets.* In the past, several of the Company's larger customers have entered into joint ventures ("JV") with European, Japanese or Pacific Rim semiconductor manufacturers. In certain instances, the Company has encountered intense price competition from foreign competitors who are suppliers to the non-U.S. member of the JV. Further, in certain instances the Company has not secured the equipment order when the non-U.S. member has had the responsibility for selecting the equipment to be used by the JV in its U.S. operations. There can be no assurance that as the Company's customers form additional alliances, whether in the U.S. or in other parts of the world, that the Company will be successful in obtaining equipment orders or that it will be able to obtain orders with sufficient gross margin to generate profitable transactions, either of which could have an adverse effect on the Company's results of operations.* Throughout the Pacific Rim, the Company is attempting to compete with major equipment suppliers having significant market share and established service and support infrastructures 40 29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS in place. Although the Company has invested in the staffing and facilities that it believes are necessary to sell, service and support customers in the Pacific Rim, it anticipates that it will encounter significant price competition as well as competition based on technological ability.* There can be no assurance that the Company's Pacific Rim operations will be profitable, even if it is successful in obtaining significant sales in this region.* Further, due to recent economic issues in certain Asian countries, particularly Korea, as well as the current extended downturn in demand for semiconductor manufacturing equipment, the Company's ability to penetrate such markets has been diminished. Failure to secure customers in these markets would have an adverse effect on the Company's business and results of operations.* YEAR 2000. As the Year 2000 approaches, a universal issue has emerged regarding how existing application software programs and operating systems can accommodate date values. The Company has completed the modification of its internal-use computer software for the Year 2000. The third party costs associated with such modifications were not material and were expensed in fiscal 1998. The Company does not segregate internal costs incurred to assess and remedy deficiencies related to the Year 2000 problem or modifications to its products, however, the Company has incurred approximately $124,000 with third parties to identify and modify its internal-use computers systems. Although the company believes that the solutions, which were extensively tested, have resulted in its internal-use systems being Year 2000 compliant, there can be no assurance that unforeseen problems that could disrupt operations will arise, or that the Company could be required to expend further cost and effort to solve such problems.* The Company has evaluated its products and identified those areas containing date sensitive Year 2000 issues. The Company has informed its customers of ship dates for Year 2000 compliant products and has made available for potential sale the necessary modifications to bring previously shipped products into compliance. The Company is in the process of contacting its suppliers and service providers to ascertain their state of readiness and compliance for Year 2000 issues. The Company will continue to monitor their progress and compliance for these issues. There can be no assurance, however, that the Company's suppliers and service providers will timely provide the Company with products or services which are Year 2000 compliant. Any failure to do so by such third parties could have a material adverse impact on the Company's results of operations.* At this time the Company does not feel it is necessary to develop a contingency plan. As risks are identified, plans will be developed and implemented as required. Although the Company believes its Year 2000 plans will be successful, there can be no assurance that unforeseen problems will not happen which could have a material adverse effect on the Company.* QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company is exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The Company attempts to minimize its currency fluctuation risk by actively managing the balances of current assets and liabilities denominated in foreign currencies. The Company does not use derivative financial instruments. A 10% change in the foreign currency exchange rates would not have a material impact on the Company's results of operations. The Company has investments in marketable debt securities that are subject to interest rate risk. However, due to the short-term nature of the Company's debt investments the impact of interest rate changes would not have a material impact on the value of such investments. 41 30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company is also exposed to interest rate risk on its fixed rate debt obligations. At September 30, 1998 fixed rate debt obligations totaled $6,505,000. The fixed rate obligations range between 8.25% to 12% with a weighted average of 8.35% and maturity dates between April 1999 and February 2007. Due to the relatively insignificant principal balance of outstanding debt obligations, the Company does not actively manage the risk associated with these obligations. The impact of interest rate changes would not have a material impact on the Company's results of operations. BUSINESS INTERRUPTION. The Company manufactures its Track products in San Jose, California and substantially all of its Thermco products in Orange, California. Tinsley's optical components are manufactured in Richmond and North Hollywood, California. These California facilities are located in seismically active regions. SVGL's photolithography exposure products are manufactured in Wilton and Ridgefield, Connecticut. If the Company were to lose the use of one of its facilities as a result of an earthquake, flood or other natural disaster, the resultant interruptions in operations would have a material adverse effect on the Company's results of operations and financial condition.* SVGL--UNCERTAIN MARKET FOR MICRASCAN PRODUCTS. The Company believes that the photolithography exposure equipment market is one of the largest segments of the semiconductor processing equipment industry.* To address this market, the Company has invested and expects to continue to invest substantial resources in SVGL's Micrascan technology and its family of Micrascan deep ultraviolet ("DUV") step-and-scan photolithography products, capable of producing line widths of .18 micron and below. The development of a market for the Company's Micrascan step-and-scan photolithography products will be highly dependent on the continued trend towards finer line widths in integrated circuits. The Company believes DUV lithography will be required to fabricate devices with line widths below 0.3 micron.* Semiconductor manufacturers can purchase DUV steppers to produce product at .25 micron line widths. However, the Company believes that as devices increase in complexity and size and require finer line widths, the technical advantages of DUV step-and-scan products in the exposure of critical layers, as compared to DUV steppers, will enable semiconductor manufacturers to achieve finer line widths, higher yields and improved critical dimension control.* The Company also believes that the transition to DUV step-and-scan products for the exposure of critical layers will accelerate in calendar 1999 and that advanced semiconductor manufacturers are beginning to require volume quantities of production equipment as advanced as the current and pending versions of Micrascan to produce both critical and to some degree sub-critical layers.* Currently, competitive DUV step-and-scan equipment capable of producing .25 micron line widths is available in limited quantities from two competitors, and the Company believes that at least one other manufacturer of advanced photolithography products will begin initial shipments of step-and-scan machines in the near future.* There can be no assurance that the Company will be successful in competing with such products.* Further, if manufacturers of step-and-scan products or manufacturers of DUV steppers are able to further enhance existing technology to achieve finer line widths sufficiently to erode the competitive and technological advantages of DUV step-and-scan products, or other lithography manufacturers of step-and-scan products are able to supply products in sufficient quantity that are technically equal or better than the Micrascan, demand for the Micrascan technology may not develop as the Company expects.* The Company believes that advanced logic devices and DRAMs will require increasingly finer line widths.* Consequently, SVGL must continue to develop advanced technology equipment 42 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS capable of meeting its customers' current and future requirements while offering those customers a progressively lower cost of ownership.* In particular, the Company believes that it must continue its development of future products capable of printing line widths finer than .18 micron and processing 300mm wafers.* Any failure by the Company to develop the advanced technology required by its customers at progressively lower costs of ownership could have a material adverse impact on the Company's financial condition and results of operations.* SVGL--NEED TO INCREASE MANUFACTURING CAPACITY AND SYSTEM OUTPUT. The Company believes that its ability to supply products in volume will be a major factor in customer decisions to commit to the Micrascan technology.* Based upon its forecast of continued growth in demand, the transition from steppers to DUV step-and-scan photolithography equipment and potential future demand for advanced lithography products, the Company has been in the process of increasing SVGL's production capacity under an extremely aggressive expansion schedule. In August 1996, as part of this expansion, the Company purchased from The Perkin-Elmer Corporation a 243,000 square foot facility occupied by SVGL in Wilton, Connecticut, and an additional 201,000 square foot building, which SVGL now occupies, in Ridgefield, Connecticut. Through the first half of fiscal 1998, the Company has invested in significant capital improvements related to the buildings purchased and the equipment required to expand the production capabilities of SVGL. While the Company intends to continue certain of these expansion activities, it may not invest in all of the metrology and other equipment required to maximize manufacturing capacity until industry demand recovers.* However, the Company plans to continue increasing capacity to produce optical components, thus enabling it to quickly respond to customer requirements. Once demand recovers, the timely equipping of facilities to successfully complete the increase in capacity will require the continued recruitment, training and retention of a high quality workforce, as well as the achievement of satisfactory manufacturing results on a scale greater than SVGL has attempted in the past. There can be no assurance that the Company can manage these efforts successfully. Any failure to manage such efforts could result in product delivery delays and a subsequent loss of future revenues. In particular, the Company believes that protracted delays in delivering quantities of current and future Micrascan products could result in semiconductor manufacturers electing to install competitive equipment in their advanced fabrication facilities, which could impede acceptance of the Micrascan products on an industry-wide basis.* In addition, the Company's operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity if net sales, for any reason, do not increase commensurately.* The time required to build a Micrascan system is significant. If SVGL is to be successful in supplying increased quantities of Micrascan products, it will not only need to be able to build more products, it will need to build them faster.* SVGL will require additional trained personnel and additional raw materials and components, as well as improved manufacturing and testing techniques to both facilitate volume increases and shorten manufacturing cycle time.* To that end, SVGL is continuing to develop its vendor supply infrastructure, and implement manufacturing improvements.* Additionally, the Company believes that once industry demand recovers, it must resume increasing its factory, field service and technical support organization staffing and infrastructure to support the anticipated customer requirements.* There can be no assurance that the Company will not experience manufacturing difficulties or encounter problems in its attempt to increase production and upgrade or expand existing operations.* One of the most critical components of the Micrascan products is the projection optics, which are primarily manufactured by SVGL. As part of its overall investment in capacity, the 43 32 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Company has increased SVGL's optical manufacturing floorspace. The Company believes that in order for SVGL to be a viable supplier of advanced lithography products in the future, it must successfully reduce the cycle times required to build projection optics.* On November 26, 1997, the Company acquired TLI (See "Liquidity and Capital Resources".) The primary reasons for the acquisition were TLI's technology and expertise relating to aspherical lenses, a key component of SVGL's photolithography products, the adaptation of certain of TLI's manufacturing processes by SVGL and TLI's commencement of the fabrication of non-aspherical lenses which are currently produced by SVGL. There can be no assurance that TLI's manufacturing technology is scaleable, or that such expertise can be transferred without substantial time or expense, if at all.* The inability of SVGL to transfer this production technology for use in processes of a substantially larger scale or the inability of TLI to manufacture non-aspherical lenses for SVGL in sufficient quantities to realize efficiencies of scale could adversely affect the Company's ability to realize any significant benefits from the acquisition of TLI.* The Company believes that protracted delays in delivering quantities of both current and future generations of Micrascan products to multiple customers could result in semiconductor manufacturers electing to install competitive equipment in their advanced fabrication facilities, and could preclude industry acceptance of the Micrascan technology and products.* In addition, the Company's operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity and field service and technical support activities if net sales do not increase commensurately.* SVGL--SOLE SOURCE MATERIALS AND COMPONENTS. Most raw materials and components not produced by the Company are available from more than one supplier. However, certain raw materials, components and subassemblies are obtained from single sources or a limited group of suppliers. Although the Company seeks to reduce its dependence on these sole and limited source suppliers, and the Company has not experienced significant production delays due to unavailability or delay in procurement of component parts or raw materials to date, disruption or termination of certain of these sources could occur and such disruptions could have at least a temporary adverse effect on the Company's business and results of operations.* Moreover, a prolonged inability to obtain certain components could have a material adverse effect on the Company's business and results of operations and could result in damage to customer relationships.* The raw material for a proprietary component of the optical system for the Micrascan is available from only one supplier. The supplier has expanded its capacity to meet SVGL's projected long term requirements and has created and stored agreed upon quantities of safety stock. There can be no assurance that the supplier will be able to provide acceptable quantities of material required by SVGL.* Additionally, a version of the Company's Micrascan III photolithography system utilizes an Excimer laser that is manufactured in volume by only one supplier, which until the first quarter of fiscal 1998 was the only supplier the Company had determined could meet its specifications. SVGL has recently qualified an additional source of lasers for its current and future versions of Micrascan products, allowing the potential for the integration of such lasers into its system configurations.* However, there can be no assurance that its customers will be receptive to procuring products with lasers from this supplier, or the supplier will be able to provide product of sufficient quantity and quality. If these suppliers were unable to meet their commitments, SVGL would be unable to manufacture the quantity of products 44 33 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS required to meet the anticipated future demand, which would have a material adverse effect on the Company's business and results of operations.* SVGL--RESEARCH AND DEVELOPMENT FUNDING. Historically, the Company has depended on external funding to assist in the high cost of development in its photolithography operation. Beginning in fiscal 1996, the Company entered into agreements with certain customers (the "Participants") whereby each agreed to assist in funding the Company's development of an advanced technology 193 nanometer Micrascan system. In exchange for such funding, each Participant received the right to purchase one such system, and in addition, received a right of first refusal (ratable among such Participants) to all such machines manufactured during the first two years following the initial system shipments. For each initial system ordered, each Participant agreed to fund $5,000,000 in such development costs. The agreements call for each Participant to pay $1,000,000 of initial development funding and four subsequent payments of $1,000,000 upon the completion of certain development milestones. The Participants may withdraw from the development program without penalty, but payments made against completed development milestones are not refundable and all preferential rights to future equipment are forfeited. At September 30, 1998, the Company had received $20,000,000 in funding from Participants, of which $19,765,000 had been recognized and offset against research and development expenditures. There can be no assurances that the Participants will remain in the program.* In the event that the Company does not receive the funding anticipated under the agreements, it would be required to replace the shortfall from its own funds or other sources. If the Company were required to use its own funds, its research and development expenses would increase and its operating income would be reduced correspondingly. The agreements with the Participants stipulate that if the Company receives funding for the development program in excess of $25,000,000, it will issue, ratably to the Participants, credits totaling such excess in the form of a cash discount which can be applied to the purchase of additional products by each Participant. There is no assurance that the Company will receive all funding that it currently anticipates or that it will be able to obtain future outside funding beyond that which it is currently receiving, and any failure to do so could have a material adverse impact on the Company's results of operations.* SVGL--MARKET PENETRATION. The Company believes that for SVGL to succeed in the long term, it must sell its Micrascan products on a global basis.* The Japanese market (including fabrication plants operated outside Japan by Japanese semiconductor manufacturers), the Taiwanese market and the Korean market represent a substantial portion of the overall market for photolithography exposure equipment. To date, the Company has not been successful penetrating any of these markets. Recent economic difficulties in certain Asian economies, particularly Korea, may adversely affect the Company's ability to penetrate such markets.* SVGL--FUTURE PROFITABILITY. If SVGL is to attain its objective of being a volume supplier of advanced photolithography products, the Company believes that it must expand its customer base to include additional customers from whom it secures and successfully fulfills orders for production-quantities of Micrascan products.* The Company believes that in light of the downturn in industry demand, costs associated with the continued development of the Micrascan technology, the expansion of SVGL's manufacturing capacity, the related increase in manpower and customer support, and the potential difficulties inherent in manufacturing sub-.25 micron Micrascan products, in particular the projection optics required for these products, there can be no assurance that SVGL will be able to operate profitably in the future.* 45 34 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LEGAL PROCEEDINGS On or about August 12, 1998, Fullman International and Fullman Company (collectively, "Fullman") initiated a lawsuit in the United States District Court for the District of Oregon alleging a cause of action for fraudulent transfer in connection with a settlement the Company had previously entered into resolving its claims against a Thailand purchaser of the Company's equipment. In its complaint against the Company, the plaintiff, another creditor of the Thailand purchaser, alleges damages of approximately $11,500,000 plus interest. The Company has successfully moved to transfer the case to the United States District Court for the Northern District of California. While the outcome of such litigation is uncertain, the Company believes it has meritorious defenses to the claims and intends to conduct a vigorous defense. However, an unfavorable outcome in this matter could have a material adverse effect on the Company's financial condition.* Notwithstanding the above, the Company, from time to time, is party to various legal actions arising out of the normal course of business, none of which is expected to have a material effect on the Company's financial position or operating results. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, cash and cash equivalents and temporary investments totaled $150,000,000, down $56,661,000 from the September 30, 1997 balance of $206,661,000. The decrease was primarily due to a net loss, the purchase of property, plant and equipment, the decline in accounts payable, lower deferred and refundable income taxes which were offset in part by depreciation and amortization and the reduction of accounts receivable and inventory. On June 30, 1998, the Company entered into an unsecured $150,000,000 bank revolving line of credit agreement that expires June 30, 2001. Advances under the line bear interest at the Prime Rate or 0.65% to 1.50% over LIBOR. The agreement includes covenants regarding liquidity, profitability, leverage, coverage of certain charges and minimum net worth and prohibits the payment of cash dividends. On October 23, 1998, certain of the covenants were amended, in part to allow for the Company's fourth quarter fiscal 1998 net loss. The Company is in compliance with the covenants as amended. At December 16, 1998, there were no borrowings outstanding under the facility. On November 26, 1997, the Company acquired Tinsley Laboratories, Inc. in exchange for approximately 1,091,000 shares of the Company's Common Stock. TLI designs manufactures and sells precision optical components, assemblies and products to customers in a variety of industries and research endeavors. The transaction has been accounted for as a pooling of interests for financial reporting purposes. The Company believes that it has sufficient working capital and available bank credit to sustain operations and provide for the expansion of its business for the next twelve months.* 46 35 CORPORATE DIRECTORY DIRECTORS PAPKEN S. DER TOROSSIAN(3) Chairman of the Board and Chief Executive Officer WILLIAM A. HIGHTOWER President and Chief Operating Officer WILLIAM L. MARTIN(1,2,3) Retired Chief Executive Officer Plantronics, Inc. NAM P. SUH(3) Cross Professor, Head of the Department of Mechanical Engineering and Director of the Manufacturing Institute Massachusetts Institute of Technology KENNETH M. THOMPSON(2) Retired Vice President Technology, Manufacturing and Engineering, Intel Corp. LAWRENCE TOMLINSON(1,2) Vice President and Treasurer Hewlett-Packard (1) Audit Committee Member (2) Compensation Committee Member (3) Technical Advisory Committee Member OFFICERS PAPKEN S. DER TOROSSIAN Chairman of the Board and Chief Executive Officer WILLIAM A. HIGHTOWER President and Chief Operating Officer RUSSELL G. WEINSTOCK Vice President, Finance and Chief Financial Officer EDWARD A. DOHRING* Vice President President, SVG Lithography Systems, Inc. STEVEN L. JENSEN Vice President Worldwide Sales and Service *Retired on 12/31/98 JEFFREY M. KOWALSKI Vice President President, Thermco Systems BORIS LIPKIN Vice President Corporate LARRY W. SONSINI Secretary STOCKHOLDER INFORMATION INDEPENDENT ACCOUNTANTS Deloitte & Touche LLP San Jose, California STOCK TRANSFER AGENT Chase Mellon Shareholder Services San Francisco, California GENERAL COUNSEL Wilson Sonsini Goodrich & Rosati Palo Alto, California FORM 10-K The Company's Annual Report to the Securities and Exchange Commission on Form 10-K will be furnished without charge to stockholders upon written request to: SHAREHOLDER RELATIONS Silicon Valley Group, Inc. 101 Metro Drive, Suite 400 San Jose, California 95110 Further information on the Company's activities, additional copies of this report, the Form 10-K, or other financial materials may be obtained on the Internet at: www.svg.com ANNUAL MEETING OF STOCKHOLDERS The Company's annual meeting will be held at 3:00 p.m. on Tuesday, February 23, 1999, at the Company's offices: 2240 Ringwood Avenue San Jose, California 95131 SVG, Micrascan, and Thermco are registered trademarks and Micrascan Step-and-Scan, 200-APS, 90-S, Series 8000 AVP, and Series RVP 9000 are trademarks of Silicon Valley Group, Inc. EX-23.1 5 CONSENT OF DELOITTE & TOUCHE 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statements Nos. 33-31298, 33-85020 and 333-39499 of Silicon Valley Group, Inc. on Forms S-8 of our reports dated October 26, 1998 appearing in and incorporated by reference in this Annual Report on Form 10-K of Silicon Valley Group, Inc. for the year ended September 30, 1998. /s/ Deloitte & Touche LLP - ------------------------- DELOITTE & TOUCHE LLP San Jose, California December 29, 1998 EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS FOR FISCAL 1998 AS FILED IN THE COMPANY'S FORM 10K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998. 1,000 YEAR SEP-30-1998 OCT-01-1997 JUN-30-1998 121,575 28,425 129,794 8,232 212,975 529,762 319,234 128,212 730,590 157,802 0 0 0 404,462 157,068 730,590 608,625 608,625 408,396 408,396 0 0 1,018 (27,157) (13,580) (13,577) 0 0 0 (13,577) (0.42) (0.42)
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