-----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, IfGxjPQ8SOVS4uqzjymRBkHRlHegDJcxwV6PhHbkzzo3zOKBsIghYL5iUK0ENI6r ywe2O6w1zv7XIt0MKwxzvA== 0001047469-99-020567.txt : 19990517 0001047469-99-020567.hdr.sgml : 19990517 ACCESSION NUMBER: 0001047469-99-020567 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ULTRATECH STEPPER INC CENTRAL INDEX KEY: 0000909791 STANDARD INDUSTRIAL CLASSIFICATION: SPECIAL INDUSTRY MACHINERY, NEC [3559] IRS NUMBER: 943169580 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22248 FILM NUMBER: 99623314 BUSINESS ADDRESS: STREET 1: 3050 ZANKER RD CITY: SAN JOSE STATE: CA ZIP: 95134 BUSINESS PHONE: 4083218835 MAIL ADDRESS: STREET 1: 3050 ZANKER RD CITY: SAN JOSE STATE: CA ZIP: 95134 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999 -------------- [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- ------------ Commission File Number 0-22248 -------------------------- ULTRATECH STEPPER, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 94-3169580 - --------------------------------------- --------------------------------------- (State or other jurisdiction (I.R.S. employer identification number) of incorporation or organization) 3050 Zanker Road, San Jose, California 95134 - ---------------------------------------- --------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (408) 321-8835 -------------- - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ----- Indicate the number of shares of the issuer's class of common stock, as of the latest practical date: Class Outstanding as of May 10, 1999 - ----------------------------- ------------------------------ common stock, $.001 par value 21,262,104 1 ULTRATECH STEPPER, INC. INDEX
PAGE NO. -------- PART 1. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998........................................................ 3 Condensed Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998................................................. 4 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998........................................... 5 Notes to Condensed Consolidated Financial Statements .......................... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................... 25 PART 2. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS.............................................................. 26 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................... 26 ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................ 26 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................ 26 ITEM 5. OTHER INFORMATION.............................................................. 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................... 26 SIGNATURES...................................................................................... 27
2 PART 1. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements ULTRATECH STEPPER, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands) Mar. 31, Dec. 31, 1999 1998* - ------------------------------------------------------------------------------------ ASSETS (Unaudited) Current assets: Cash, cash equivalents and short-term investments $ 144,795 $ 146,107 Accounts receivable, net 9,856 11,899 Inventories 30,750 36,750 Current portion of leases receivable 1,885 2,012 Prepaid expenses and other current assets 5,269 5,088 - ------------------------------------------------------------------------------------ Total current assets 192,555 201,856 Equipment and leasehold improvements, net 22,275 23,319 Restricted long-term investments 5,554 5,510 Leases receivable, net 1,548 1,536 Intangbile assets, net 8,086 8,438 Other assets 5,712 5,276 - ------------------------------------------------------------------------------------ Total assets $ 235,730 $ 245,935 - ------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 1,657 $ 1,881 Accounts payable 7,820 8,541 Other current liabilities 19,258 25,017 - ------------------------------------------------------------------------------------ Total current liabilities 28,735 35,439 Other liabilities 331 345 Stockholders' equity Common Stock 21 21 Additional paid-in capital 174,214 174,155 Accumulated other comprehensive income (loss), net (237) 779 Retained earnings 32,666 35,196 - ------------------------------------------------------------------------------------ Total stockholders' equity 206,664 210,151 - ------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 235,730 $ 245,935 - ------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------
* The Balance Sheet as of December 31, 1998 has been derived from the audited financial statements as that date. SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 3 ULTRATECH STEPPER, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
- --------------------------------------------------------------------------------- Three Months Ended ----------------------- Mar. 31, Mar. 31, (In thousands, except per share amounts) 1999 1998 - --------------------------------------------------------------------------------- Net sales: Products $ 21,640 $ 24,774 Services 4,139 3,008 - --------------------------------------------------------------------------------- Total net sales $ 25,779 27,782 Cost of sales: Cost of products sold 13,949 14,099 Cost of services 3,109 1,819 - --------------------------------------------------------------------------------- Total cost of sales 17,058 15,918 - --------------------------------------------------------------------------------- Gross profit 8,721 11,864 OPERATING EXPENSES: Research, development, and engineering 6,537 7,173 Amortization of goodwill 307 38 Selling, general, and administrative 6,254 6,438 - --------------------------------------------------------------------------------- Operating loss (4,377) (1,785) Interest expense (121) (27) Interest and other income, net 1,969 1,703 - --------------------------------------------------------------------------------- Loss before income taxes (2,529) (109) Income taxes (benefit) -- (470) - --------------------------------------------------------------------------------- Net income (loss) ($ 2,529) $ 361 - --------------------------------------------------------------------------------- - --------------------------------------------------------------------------------- Net income (loss) per share - basic ($ 0.12) $ 0.02 Number of shares used in per share computations - basic 21,124 20,833 Net income (loss) per share - diluted ($ 0.12) $ 0.02 Number of shares used in per share computations - diluted 21,124 21,697 - --------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4 ULTRATECH STEPPER, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended ---------------------- MAR. 31, Mar. 31, (In thousands) 1999 1998 - ---------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ($ 2,529) $ 361 Charges to income not affecting cash 2,603 2,444 Net effect of changes in operating assets and liabilities 779 (2,067) - ---------------------------------------------------------------------------------------------- Net cash provided by operating activities 853 738 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (1,501) (6,609) Net reduction in available-for-sale securities 10,422 2,243 Segregation of restricted investments (86) (51) - ---------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities 8,835 (4,417) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of notes payable -- 12 Repayment of note payable (224) -- Net proceeds from issuance of common stock pursuant to employee stock plans 60 767 - ---------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (164) 779 Net increase (decrease) in cash and cash equivalents 9,524 (2,900) Cash and cash equivalents at beginning of period 54,142 43,898 - ---------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 63,666 $ 40,998 - ----------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5 ULTRATECH STEPPER, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 1999 (1) BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. USE OF ESTIMATES - The preparation of the accompanying unaudited condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. RECLASSIFICATIONS - Certain condensed consolidated financial statement amounts have been reclassified for consistent presentation. The Company's first fiscal quarter in 1999 and 1998 ended on April 3, 1999 and April 4, 1998, respectively. For convenience of presentation, the Company's financial statements have been shown as ending on March 31, 1999 and March 31, 1998. Operating results for the three-month period ended March 31, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999, or any future period. (2) INVENTORIES Inventories consist of the following:
Mar. 31, 1999 Dec. 31, 1998 ------------- ------------- (In thousands) (Unaudited) Raw materials .......................................... $14,258 $19,677 Work-in-process ........................................ 11,617 8,799 Finished products ...................................... 4,875 8,274 ------- ------- $30,750 $36,750 ------- -------
(3) OTHER CURRENT LIABILITIES Other current liabilities consist of the following:
Mar. 31, 1999 Dec. 31, 1998 ------------- ------------- (In thousands) (Unaudited) Salaries and benefits .................................. $ 3,138 $ 3,865 Warranty reserves ...................................... 4,003 4,207 Advance billings ....................................... 1,053 1,694 Income taxes payable ................................... 1,587 1,630 Sales returns and allowances ........................... 2,000 2,000 Reserve for losses on purchase order commitments ....... 3,374 5,849 Other .................................................. 4,103 5,772 ------- ------- $19,258 $25,017 ------- ------- ------- -------
(4) COMPUTATION OF NET INCOME (LOSS) PER SHARE The following sets forth the computation of basic and diluted net income (loss) per share: 6
Three Months Ended ------------------------ Mar. 31, Mar. 31, (Unaudited, in thousands, except per share amounts) 1999 1998 - ---------------------------------------------------------------------------------------- Numerator: Net income (loss) ($ 2,529) $ 361 Denominator: Denominator for basic net income (loss) per share 21,124 20,833 Effect of dilutive employee stock options -- 864 -------- -------- Denominator for diluted net income (loss) per share 21,124 21,697 -------- -------- Net income (loss) per share - basic ($ 0.12) $ 0.02 -------- -------- -------- -------- Net income (loss) per share - diluted ($ 0.12) $ 0.02 -------- -------- -------- --------
For the three-month period ended March 31, 1999, options to purchase 3,004,000 shares of Common Stock at an average exercise price of $16.88 were excluded from the computation of diluted net loss per share as the effect would have been antidilutive. This compares to the exclusion of 439,000 options at an average exercise price of $29.81 for the three-month period ended March 31, 1998. Options are anti-dilutive when the Company has a net loss or when the exercise price of the stock option is greater than the average market price of the Company's Common Stock. (5) COMPREHENSIVE INCOME (LOSS) The Company adopted the Statement of Financial Accounting Standards No. 130 (FAS 130) "Reporting Comprehensive Income" in the first fiscal quarter of 1998. FAS130 establishes new rules for the reporting and display of comprehensive income and its components. However it does not affect net income or total stockholders' equity. The components of comprehensive income (loss) are as follows:
Three Months Ended Mar. 31 -------------------------- (Unaudited, in thousands) 1999 1998 - ---------------------------------------------------------------------------------------------------------- Net income (loss) ............................................................ ($2,529) $ 361 Accumulated other comprehensive income (loss) ............................... Unrealized holding gain (loss) on available-for-sale securities.......... (1,016) 134 Tax effect .............................................................. -- -- - ---------------------------------------------------------------------------------------------------------- Comprehensive income (loss) .................................................. ($3,545) $ 495 - ----------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income (loss) presented in the accompanying condensed consolidated balance sheets consists entirely of accumulated unrealized holding gain (loss) on available-for-sale securities. The unrealized holding gain (loss) on available-for-sale securities is not currently adjusted for income taxes as a result of the Company's operating losses. (6) COMPANY AND INDUSTRY INFORMATION The Company adopted the Statement of Financial Accounting Standards No. 131 (FAS 131), "Disclosures about Segments of an Enterprise and Related Information," on December 31, 1998. The new rule established standards for public companies relating to the reporting of financial information about operating segments. The Company operates in one business segment, which is the manufacture and distribution of photolithography equipment to manufacturers of integrated circuits, photomasks for the production of integrated circuits, thin film heads and micromachined components. 7 (7) ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. In June 1999, the Financial Accounting Standards Board issued Statement No. 133 (FAS 133), "Accounting for Derivative Instruments and Hedging Activities", which is required to be adopted in years beginning after June 15, 1999. Because of the Company's minimal use of derivatives, management does not anticipate that the adoption of the new Statement will have a significant effect on earnings or the financial position of the Company. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Ultratech develops, manufactures and markets photolithography equipment (steppers) designed to reduce the cost of manufacturing integrated circuits, thin film heads for disk drives and micromachined components. The Company supplies step-and-repeat systems based on one-to-one and reduction optical technologies to customers located throughout the United States, Europe, Asia/Pacific and Japan. These products range from low-cost systems for high-volume manufacturing to advanced systems for cost-effective production of leading-edge devices and for research and development applications. Additionally, the Company manufactures and markets the UltraBeam "V" Model electron beam pattern generation system based on vector-scan technology for use in the development and production of photomasks for the integrated circuits ("IC") industry. On June 11, 1998, the Company completed the acquisition of substantially all of the assets and the assumption of certain liabilities of Integrated Solutions, Inc.("ISI"), a privately held manufacturer of i-line and deep ultra-violet reduction lithography systems (the "Acquisition") for approximately $19.2 million in cash, $2.6 million in transaction costs and the assumption of certain liabilities. The following discussion should be read in conjunction with the Company's 1998 Annual Report on Form 10-K, which is available upon request. RESULTS OF OPERATIONS The Company's operating results have fluctuated significantly in the past and will continue to fluctuate significantly in the future depending upon a variety of factors, including substantial cyclicality in the Company's target markets; various competitive factors including price-based competition and competition from vendors employing other technologies; the timing and terms of significant orders; lengthy sales cycles for the Company's products; inventory and open purchase commitment reserve positions; concentration of credit risk; delayed shipments to customers due to customer configuration changes and other factors; acquisition activities requiring the devotion of substantial management resources; the mix of products sold; lengthy manufacturing cycles for the Company's products; lengthy product development cycles for new products; the timing of new product announcements and releases by the Company or its competitors; market acceptance of new products and enhanced versions of the Company's products; manufacturing inefficiencies associated with the startup of new product introductions; customer concentration; ability to volume produce systems and meet customer requirements; patterns of capital spending by customers; product discounts; changes in pricing by the Company, its competitors or suppliers; political and economic instability throughout the world, in particular the Asia/Pacific region; natural disasters; regulatory changes; and business interruptions related to the Company's occupation of its facilities. The Company's gross profit as a percentage of sales has been and will continue to be significantly affected by a variety of factors, including inventory and open purchase commitment reserve provisions; the rate of capacity utilization; the mix of products sold; nonlinearity of shipments during the quarter; increased competition in the Company's targeted markets; the introduction of new products, which typically have higher manufacturing costs until manufacturing efficiencies are realized and are typically discounted more than existing products until the products gain market acceptance; the percentage of international sales, which typically have lower gross margins than domestic sales principally due to higher field service and support costs; and the implementation of subcontracting arrangements. The Company derives a substantial portion of its total net sales from sales of a relatively small number of newly manufactured systems, which typically range in price from $800,000 to $2.1 million for the Company's 1X steppers, and $1.5 million to $4.0 million for the Company's reduction steppers. Additionally, the Company's UltraBeam electron beam lithography system is anticipated to sell in a range of $6.0 million to $9.0 million. As a result of these high sale prices, the timing of recognition of revenue from a single transaction has had and will continue to have a significant impact on the 9 Company's net sales and operating results. The Company's backlog at the beginning of a period typically does not include all of the sales needed to achieve the Company's objectives for that period. In addition, orders in backlog are subject to cancellation, delay, deferral or rescheduling by a customer with limited or no penalties. Consequently, the Company's net sales and operating results for a period have been and will continue to be dependant upon the Company obtaining orders for systems to be shipped in the same period in which the order is received. The Company's business and financial results for a particular period could be materially adversely affected if an anticipated order for even one system is not received in time to permit shipment during the particular period. Furthermore, a substantial portion of the Company's net sales has historically been realized near the end of each quarter. Accordingly, the failure to receive anticipated orders or delays in shipments near the end of a particular quarter, due, for example, to reschedulings, delays, deferrals or cancellations by customers, additional customer configuration requirements, or to unexpected manufacturing difficulties or delays in deliveries by suppliers due to their long production lead times or otherwise, has caused and may continue to cause net sales in a particular period to fall significantly below the Company's expectations, which has and could continue to materially adversely affect the Company's operating results for such period. In particular, the long manufacturing cycles of the Company's Titan Wafer Stepper(R) and Saturn Wafer Stepper(R), and the Company's newly acquired XLS advanced reduction stepper and 193nm small-field research and development reduction stepper (both product lines were acquired through the acquisition of certain assets and liabilities of ISI), and the long lead time for lenses and other materials, could cause shipments of such products to be delayed from one quarter to the next, which could materially adversely affect the Company's financial condition and results of operations for a particular quarter. Additionally, the Company has very limited experience in the manufacture of its UltraBeam electron beam pattern generation systems. The UltraBeam systems are extremely complex and the product has significantly long manufacturing and sales cycles, which greatly increases the likelihood of delays in shipments from one quarter to the next. Due to the high list price for these systems, shipment delays would materially adversely affect the Company's financial condition and results of operations for a particular quarter if the shipment were delayed to the following quarter. Additionally, the Company may experience difficulties in assimilating the operations acquired in the Acquisition. (See " Additional Risk Factors: Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). The impact of these and other factors on the Company's sales and operating results in any future period cannot be forecast with certainty. The Company's business has in prior years been subject to seasonality, although the Company believes such seasonality has been masked in recent years by cyclical trends within the semiconductor and thin film industries. In addition, the need for continued expenditures for research and development, capital equipment purchases and ongoing training and customer service and support worldwide, among other factors, will make it difficult for the Company to reduce its significant operating expenses in a particular period if the Company fails to achieve its net sales goals for the period. Additionally, the Company has recently experienced manufacturing inefficiencies associated with shifts in product demand and under-utilization of manufacturing capacity and the Company presently anticipates that these trends will continue for at least the next few quarters. Such continuation would materially adversely affect the Company's business, financial condition and results of operations. The Company presently expects that net sales for the three-month period ending June 30, 1999 may be higher than net sales in the comparable period in 1998. However, due to lack of order visibility, the Company can give no assurance that it will be able to achieve or maintain its current sales levels. The Company presently expects to recognize an operating and net loss for the quarter ending June 30, 1999. These losses may extend to future quarters due, in part, to the significant level of planned research, development and engineering spending, relative to anticipated sales; the current low rate of capacity utilization; and the current backlog and order levels for the Company's products. Certain of the statements contained in this report may be considered forward-looking statements that may involve a number of risks and uncertainties. In addition to the factors discussed herein, among other factors that could cause actual results to differ materially include the following: highly 10 competitive industry; difficulties in assimilating acquired operations; international sales; development of new product lines; rapid technological change; importance of timely product introductions; importance of the Company's mix-and-match strategy; year 2000 compliance; future acquisitions; expansion of the Company's product lines; dependence on key personnel; sole or limited sources of supply; intellectual property matters; environmental regulations; effects of certain anti-takeover provisions; volatility of stock price; and the other risk factors listed from time to time in the Company's SEC reports. Due to these and additional factors, certain statements, historical results and percentage relationships discussed below will not necessarily be indicative of the results of operations for any future period. NET SALES Net sales consist of revenue from system sales, spare parts sales, and service. For the quarter ended March 31, 1999, net sales were $25.8 million, a decrease of 7% as compared with net sales of $27.8 million for the comparable period in 1998. The decline, relative to the 1998 period, was primarily attributed to the continued weak market conditions in both the semiconductor and thin film head industries and the related markets for capital equipment. The Company experienced lower unit system shipments to the thin film head and micromachining industries, continued competitive pressure on selling prices and decreased sales of spare parts and system upgrades, partially offset by unit strength in selected semiconductor applications and increased service revenues. The weakness in thin film head system shipments was primarily related to lower demand for the Company's advanced systems for front-end applications. For the quarter ended March 31, 1999, international net sales were $11.6 million, as compared with $13.7 million for the comparable period in 1998. International net sales represented 45% of total net sales for the quarter ended March 31, 1999, as compared with 49% for the comparable period in 1998. The Company continues to be cautious in its outlook for the Asian markets. The Company believes that the severe currency and equity market fluctuations that have been experienced recently by many of the Asian markets have resulted, and may continue to result, in delays, deferrals and cancellations of orders of the Company's products, particularly in the short-term, which will have a material adverse effect on the Company's business, financial condition and results of operations. The Company's operations in foreign countries are not generally subject to significant exchange rate fluctuations, principally because sales contracts for the Company's systems are generally denominated in U.S. dollars. In Japan, however, orders are typically denominated in Japanese yen. This may subject the Company to a higher degree of risk from currency fluctuations. The Company attempts to mitigate this exposure through the use of foreign exchange contracts; however, there can be no assurance of the success of any such efforts. International sales expose the Company to a number of additional risks, including fluctuations in the value of local currencies relative to the U.S. dollar, which, in turn, impact the relative cost of ownership of the Company's products. (See "Additional Risk Factors: International Sales; Japanese Market"). The Company believes that its sales have been and continue to be adversely impacted by reduced capital capacity spending levels within the semiconductor and thin film head industries. During 1997 and 1998, the Company experienced a significant level of shipment delays and purchase order restructurings by several of its customers, and also experienced purchase order cancellations. There can be no assurance that this trend will not continue in the future. Accordingly, the Company can give no assurance that it will be able to achieve or maintain its current or prior level of sales. The Company believes that the current strength of the U.S. dollar, particularly in relation to the Japanese yen, places the Company at a competitive disadvantage. Additionally, the thin film head industry is presently in the process of transitioning from the production of magneto-resistive heads to giant magneto-resistive heads. This transition could disrupt the flow of orders for new equipment from the thin film head industry until, among other factors, customer requirements are more fully defined. The Company presently expects that net sales for the three-month period ending June 30, 1999 may be higher than net sales in the comparable period in 11 1998. However, due to lack of order visibility, the Company can give no assurance that it will be able to achieve or maintain its current sales levels. Because the Company's net sales are subject to a number of risks, including intense competition in the capital equipment industry and the timing and market acceptance of the Company's products, there can be no assurance that the Company will exceed or maintain its current level of net sales for any period in the future. Additionally, the Company believes that the market acceptance and volume production of its UltraBeam electron beam lithography system, XLS advanced reduction stepper (acquired from ISI), and its Titan, Saturn and 1000 series families of wafer steppers, are of critical importance to its future financial results. To the extent that these products do not achieve significant sales due to difficulties involving manufacturing or engineering, the inability to reduce the current long manufacturing cycles for such products, competition, excess capacity in the semiconductor industry, or any other reason, the Company's business, financial condition and results of operations would be materially adversely affected. GROSS PROFIT The Company's gross profit as a percentage of net sales ("gross margin") was 33.8% for the quarter ended March 31, 1999, as compared with gross margin of 42.7% for the comparable period in 1998. On a comparative basis, gross margin for the quarter ended March 31, 1999 was adversely impacted by the mix of products sold, competitive pressure on selling prices, lower levels of capacity utilization and lower gross margins on service revenues. The Company believes that intense competition, together with generally weak conditions in the markets the Company serves, will make it difficult for the Company to significantly increase gross margin percentages in the near term. Additionally, in 1998, the Company added capacity for the anticipated volume production of several new products that are outside the Company's core reflective and refractive optical technologies. In addition to the purchase of significant levels of plant and equipment for these new products, the commencement of production of the UltraBeam electron beam lithography system has resulted and will continue to result in the purchase and retention of significant levels of inventory to support manufacturing requirements, hiring of additional production and manufacturing support personnel and the incurrence of other related manufacturing overhead costs. (See "Additional Risk Factors: Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). The purchase of additional inventories will continue to result in a significantly higher risk of obsolescence, which has required and may continue to require additional inventory write-offs, which negatively impact gross margins. Additionally, new products generally have lower gross margins until production and after-sales efficiencies can be achieved. Should these new products, including products recently acquired in the Acquisition, fail to develop or generate significant market demand, the Company's business, financial condition and results of operations would be materially adversely affected. RESEARCH, DEVELOPMENT AND ENGINEERING EXPENSES The Company's research, development and engineering expenses, net of third party funding for certain projects, were $6.5 million for the quarter ended March 31, 1999, as compared with $7.2 million for the comparable period in 1998. As a percentage of net sales, research, development and engineering expenses were 25.4% for the quarter ended March 31, 1999, as compared with 25.8% for the comparable period in 1998. This decline, in absolute dollars, was primarily related to cost containment measures implemented during the second half of 1998, partially offset by higher spending on the Company's newly acquired reduction stepper family of products. The Company continues to invest significant resources in the development and enhancement of its UltraBeam electron beam lithography system and in the development of its Verdant rapid thermal annealing/laser doping systems and technologies, together with continuing expenditures for its 1X optical products and technologies. Additionally, in June of 1998 the Company commenced research, development and engineering spending in the area of reduction lithography, as a direct result of the 12 Acquisition. The Company presently expects that the absolute dollar amount of research, development and engineering expenses for the remainder of 1999 will increase, relative to the quarter ended March 31, 1999. (See "Additional Risk Factors: Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). AMORTIZATION OF GOODWILL Amortization of goodwill was $307,000 for the quarter ended March 31, 1999, as compared with $38,000 for the comparable period in 1998. The additional amortization expense was directly related to intangible assets resulting from the Acquisition. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $6.3 million for the quarter ended March 31, 1999, as compared with $6.4 million for the comparable period in 1998. As a percentage of net sales, selling, general and administrative expenses increased to 24.3% of net sales for the quarter ended March 31, 1999, as compared to 23.2% of net sales for the comparable period in 1998. The decrease, in absolute dollars, was primarily due to cost containment measures implemented during the second half of 1998, partially offset by higher expenses as a result of the Acquisition and higher expenses in Japan as a result of the establishment of a direct sales force and demonstration facility. The Company presently anticipates that selling, general and administrative expenses for the remainder of 1999 will increase, relative to the quarter ended March 31, 1999, due primarily to seasonal factors and a reduced schedule of plant shutdowns. (See "Additional Risk Factors: Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). INTEREST AND OTHER INCOME, NET Interest and other income, net, which consists primarily of interest income, was $2.0 million for the quarter ended March 31, 1999, as compared with $1.7 million for the comparable period in 1998. This increase in interest and other income, net, was primarily related to capital gains recognized on the sale of certain of the Company's marketable securities. INCOME TAXES (BENEFIT) The Company did not recognize an income tax benefit on its pre-tax loss for the quarter ended March 31, 1999, due to uncertainty related to the utilization of its net operating loss carryforward. During the quarter ended March 31, 1998, the Company recognized a tax benefit of $470,000, primarily as a result of the carry back of certain tax benefits. LIQUIDITY AND CAPITAL RESOURCES Cash flows provided by operating activities were $0.9 million for the quarter ended March 31, 1999, as compared with $0.7 during the comparable period in 1998. Positive cash flows from operating activities during the quarter ended March 31, 1999 were primarily attributed to a reduction in inventories of $6.0 million, a reduction in net accounts and leases receivable of $2.2 million and non-cash charges to income of $2.6 million, partially offset by a reduction in current liabilities of $6.7 million and the net loss of $2.5 million. The Company sells certain of its accounts and leases receivable in order to mitigate its credit risk and to enhance cash flow. Sales of accounts receivable typically precede final customer acceptance of the system. Among other terms and conditions, the agreements include provisions that require the Company to repurchase receivables if certain conditions are present including, but not limited to, disputes with the customer regarding suitability of the product, and from time-to-time the Company has repurchased certain accounts receivable in accordance with these terms. At March 31, 1999, $11.6 million of sold accounts receivable and approximately $10.3 million of sold leases receivable were outstanding to third-party financial institutions. The Company may continue to attempt to mitigate the impact of extended payment terms and non-linear shipments by selling up to a substantial portion of its accounts receivable in the future. There can be no assurance that this financing will be available on reasonable terms, or at all. 13 The Company believes that because of the relatively long manufacturing cycle of certain of its systems, particularly newer products, the Company's inventories will continue to represent a significant portion of working capital. Additionally, as of March 31, 1999, the Company had approximately $4.7 million of net inventories and $6.9 million of net long-lived assets related to several new product lines. As such, these assets may be subject to a greater risk of impairment, which could materially adversely affect the Company's operating results and financial condition. During the quarter ended March 31, 1999, the Company generated $8.8 million of cash from its investing activities, as a net reduction in "available-for-sale" securities of $10.4 million was partially offset by a cash investment of $1.5 million for capital expenditures. Cash used in financing activities was $0.2 million during the quarter ended March 31, 1999, primarily a result of the repayment of a note payable. At March 31, 1999, the Company had working capital of $163.8 million. The Company's principal sources of liquidity at March 31, 1998 consisted of $144.8 million in cash, cash equivalents and short-term investments. The development and manufacture of new lithography systems and enhancements are highly capital-intensive. In order to be competitive, the Company must continue to make significant expenditures for capital equipment, sales, service, training and support capabilities; investments in systems, procedures and controls; expansion of operations and research and development, among many other items. The Company expects that anticipated cash flow from operations, its cash, cash equivalents and short-term investments and funds available under its lines of credit will be sufficient to meet the Company's cash requirements for the next twelve months. Beyond the next twelve months, the Company may require additional equity or debt financing to address its working capital or capital equipment needs. Additionally, the Company may in the future pursue additional acquisitions of complementary product lines, technologies or businesses. Future acquisitions by the Company may result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to goodwill and other intangible assets, which could materially adversely affect any Company profitability. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies; the diversion of management's attention from other business concerns; risks of entering markets in which the Company has no or limited direct experience; and the potential loss of key employees of the acquired company. In the event the Company acquires product lines, technologies or businesses which do not complement the Company's business, or which otherwise do not enhance the Company's sales or operating results, the Company may incur substantial write-offs and higher recurring operating costs, which could have a material adverse effect on the Company's business, financial condition and results of operations. In the event that any such acquisition does occur, there can be no assurance as to the effect thereof on the Company's business or operating results. Additionally, the Company is experiencing continued interest in its equipment leasing program and this may result in the further formation of significant long-term receivables, which, in turn, would require the use of substantial amounts of working capital. The formation of significant long-term receivables and the granting of extended customer payment terms exposes the Company to additional risks, including potentially higher customer concentration and higher potential operating expenses relating to customer defaults. During the three-month periods ended September 30, 1998 and December 31, 1998, the Company took significant reserves against potentially non-performing leases receivable. If defaults on additional lease receivables were to occur, the Company's business, financial condition and results of operations would be materially adversely affected. To the extent that the Company's financial resources are insufficient to fund the Company's activities, additional funds will be required. There can be no assurance that additional financing will be available on reasonable terms, or at all. 14 YEAR 2000 READINESS DISCLOSURE: Many currently installed computer systems and software products are coded to accept only two digit entries in the attached date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than one year, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" (Y2K) requirements. The Company has provided an assessment, below, of the state of readiness of its information and non-information technology systems, together with a summary of the status of related testing, remediation and implementation. The Company presently estimates that the total cost for the entire Y2K project will approximate $1.1 million dollars and that the remaining project cost is approximately $200,000. The Company plans to fund these remaining costs from cash generated by operations or from cash and short-term investments on hand. However additional requirements may be identified and unscheduled costs may be incurred as the project proceeds. Accordingly, there can be no assurance that the Company, or its vendors, will be able to timely and cost-effectively update its products to avoid Y2K date errors, and this may result in material costs to the Company, including costs associated with detecting and fixing such errors and costs incurred in litigation due to any such errors. Many commentators have predicted that a significant amount of litigation will arise out of year 2000 compliance issues and the Company is aware of several such suits that are currently pending. Because of the unprecedented nature of such litigation and the highly technical nature of the Company's products, there can be no assurance that the Company will not be materially adversely affected by claims related to Y2K compliance. Although the Company presently believes that it has made required changes to the software in its products, it believes that the most likely worst case scenario is from unknown impacts to its customers' manufacturing processes, which could potentially adversely impact product yields and throughput. In addition to possible litigation, the Company could incur substantially higher product returns and warranty related expenses, either of which could materially adversely affect the Company's business, financial condition and results of operations. Additionally, the Company's customers may be required to devote substantial financial resources to their own internal Y2K audit and compliance. This may result in fewer financial resources available to purchase the Company's products, fewer system sales by the Company, and could have a material adverse affect on the Company's business, financial condition and results of operations. The Company believes that its own Y2K efforts have resulted, and will continue to result in, a diversion of management and financial resources, which has further resulted in the delay or deferral of various information technology and engineering projects. INFORMATION TECHNOLOGY SYSTEMS: The Company has commenced, for all of its information systems, a Y2K conversion project to address necessary code changes, testing, and implementation and contingency plans. The Company has completed testing and verification of its primary business/information system and has identified the significant potential risks associated with Y2K. The Company believes it has remedied these potential errors and has completed the related compliance testing. The Company has also provided for contingency plans to further minimize risks to its business system associated with Y2K. Although the Company is not aware of any remaining material operational issues or costs associated with preparing its internal systems for Y2K, there can be no assurance that the Company will not experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in technology used in its internal operating systems, which are composed primarily of third party software and hardware technology. Additionally, although the Company has made inquiries of its key information technology vendors, and is in the process of collecting and reviewing survey responses, the Company believes it will not be able to obtain adequate assurances from all its key vendors. Even where assurances are received from third parties, there remains a risk that failure of systems and products of other companies on which the Company relies could have a material adverse affect on the Company. Accordingly the Company continues to assess the degree of risk to the Company and is preparing contingency plans. The Company is presently working to minimize risk from 15 vendors through understanding and implementing necessary remediation and/or contingency plans. There can be no assurance that such contingency plans will be adequate and that the Company will not incur significant additional costs or business interruptions in connection with such transition, either of which could have a material adverse affect on the Company's business, financial condition and results of operations. NON-INFORMATION TECHNOLOGY SYSTEMS: The Company has commenced, for all of its key vendors, physical plant and software contained in the products it sells, a Y2K conversion project to address necessary remediation, testing, implementation and contingency plans. The Company believes it has identified and implemented the required changes for its products' hardware and software components to attain Y2K readiness and is currently working with customers to assist in understanding these requirements. The Company has obligations to provide these modifications to customers with systems under warranty or currently under service contract. The Company has commenced the process of installing and testing these upgrades at customer sites and presently expects this process to be completed on a timely basis. In addressing customer inquiries regarding the Company's Y2K readiness and in making inquiries of the Company's vendors, the Company has adopted the Sematech process for investigating and responding to the Y2K subject. This process includes a survey form, a readiness matrix and a testing scenario. Although the Company has made inquiries of its key physical plant and materials vendors in order to assess their state of readiness, and is in the process of collecting and reviewing survey responses, the Company believes it will not be able to obtain adequate assurances from all its key vendors. Even where assurances are received from third parties, there remains a risk that failure of systems and products of other companies on which the Company relies could have a material adverse affect on the Company. Accordingly the Company continues to assess the degree of risk to the Company and is preparing contingency plans. These contingency plans may result, among other things, in the development of alternative suppliers and the purchase of additional inventories. The Company is presently working to minimize risk from vendors through understanding and implementing necessary remediation and/or contingency plans. There can be no assurance that such contingency plans will be adequate and that the Company will not incur significant additional costs or business interruptions in connection with such transition, either of which could have a material adverse affect on the Company's business, financial condition and results of operations. The foregoing statements are based upon management's best estimates at the present time, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. There can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, the nature and amount of programming required to upgrade or replace each of the affected programs, the rate and magnitude of related labor and consulting costs and the success of the Company's external customers and vendors in addressing the Y2K issue. The Company's evaluation is ongoing and it expects that new and different information will become available to it as that evaluation continues. Consequently, there is no guarantee that all material elements will be Y2K ready in time. ADOPTION OF THE EURO The Company does not presently expect that introduction and use of the Euro will materially affect the Company's foreign exchange and hedging activities or the Company's use of derivative instruments. Management does not expect that the introduction of the Euro will result in any material increase in costs to the Company and all costs, if any, associated with the introduction of the Euro will be expensed to operations as incurred. While the Company will continue to evaluate the impact of the Euro introduction over time, based on currently available information, management does not believe that the introduction of the Euro currency will have a material adverse impact on the Company's financial condition or overall trends in results of operations. 16 ADDITIONAL RISK FACTORS CYCLICALITY OF SEMICONDUCTOR AND THIN FILM HEAD INDUSTRIES The Company's business depends in significant part upon capital expenditures by manufacturers of semiconductors, photomasks and thin film head magnetic recording devices, which in turn depend upon the current and anticipated market demand for such devices and products utilizing such devices. The semiconductor industry is highly cyclical and historically has experienced recurring periods of oversupply, as evidenced by the current prolonged downturn in the semiconductor capital equipment industry. This has, from time to time, resulted in significantly reduced demand for capital equipment including the systems manufactured and marketed by the Company. The Company believes that markets for new generations of semiconductors will also be subject to similar fluctuations. In the past, the semiconductor industry has experienced significant growth, which, in turn, has caused significant growth in the capital equipment industry. However, the semiconductor industry has been experiencing a substantial and lengthy cyclical downturn, which has resulted in a significant reduction in capital spending. Additionally, in 1997 and 1998 the Company experienced cancellation of purchase orders, shipment delays and purchase order restructurings by several of its customers and there can be no assurance that this trend will not continue in the future. Accordingly, the Company can give no assurance that it will be able to achieve or maintain its current level of sales. The Company attempts to mitigate the risk of cyclicality by participating in both the semiconductor and thin film head markets, as well as diversifying into new markets such as photolithography for micromachining and the development of photomasks. Despite such efforts, when one or more of such markets experiences a downturn or slowdown, such as is currently occurring in the semiconductor and thin film head markets, the Company's net sales and operating results continue to be materially adversely affected, which has resulted in net losses for the Company in 1998 and the quarter ended March 31, 1999. The Company presently expects that net sales for the three-month period ending June 30, 1999 may be higher than net sales in the comparable period in 1998. However, due to lack of order visibility, the Company can give no assurance that it will be able to achieve or maintain its current sales levels. The Company presently expects to recognize an operating and net loss for the quarter ending June 30, 1999. These losses may extend to future quarters due, in part, to the significant level of planned research, development and engineering spending, relative to anticipated sales; the current low rate of capacity utilization; and the current backlog and order levels for the Company's products. During 1998 and 1997, approximately 50% of the Company's net sales were derived from sales to thin film head manufacturers and micromachining customers. The thin film head industry is highly cyclical, which has historically resulted in recurring periods of oversupply. The Company's business and operating results would be materially adversely affected by a further downturn or slowdown in the thin film head market or by loss of market share. HIGHLY COMPETITIVE INDUSTRY The capital equipment industry in which the Company operates is intensely competitive. A substantial investment is required to install and integrate capital equipment into a semiconductor or thin film head production line. The Company believes that once a device manufacturer has selected a particular vendor's capital equipment, the manufacturer generally relies upon that equipment for the specific production line application and, to the extent possible, subsequent generations of similar products. Accordingly, it is difficult to achieve significant sales to a particular customer once another vendor's capital equipment has been selected. The Company experiences intense competition worldwide from a number of leading foreign and domestic stepper manufacturers, such as Nikon Inc. ("Nikon"), Canon Inc. ("Canon"), ASM Lithography, Ltd. ("ASML") and Silicon Valley Group ("SVG"), Inc.'s Micralign products, all of which have substantially greater financial, marketing, technical and other resources than the Company. Nikon supplies a 1X stepper for use in the manufacture of liquid crystal displays and Canon, Nikon and ASML offer reduction steppers for thin film head fabrication. Additionally, the XLS reduction stepper product line acquired by the Company from ISI competes directly with advanced reduction steppers offered by Canon, Nikon and ASML. The 17 Company believes that future thin film head production will involve manufacturing steps that require critical feature sizes. Although the reduction stepper product lines acquired from ISI address critical feature sizes, additional development of these product lines may be necessary to fully address the unique requirements of thin film head manufacturing. Additionally, in the market for mix-and-match semiconductor applications, Nikon and Canon are shipping their own widefield mix-and-match lithography systems. (See: "Additional Risk Factors: Importance of Mix-and-Match Strategy"). ASML has recently announced its intent to compete in the low-cost lithography market. In addition, ASML and Nikon have each introduced an i-line step-and-scan system as a lower cost alternative to the Deep ultra-violet ("DUV") step-and-scan system for use on the less critical layers. These systems are expected to compete with widefield steppers, such as the Saturn and Titan families, for advanced mix-and-match applications. The Company's UltraBeam "V" model electron beam pattern generation system competes against systems produced by ETEC Systems, Inc.; Hitachi, Ltd.; Leica Camera AG; and JEOL, Ltd. ("Japan Electron Optical Laboratory"). In addition, the Company believes that the high cost of developing new lithography tools has caused its competitors to collaborate with customers and other parties in various areas such as research and development, manufacturing and marketing, thereby resulting in a combined competitive threat with significantly enhanced financial, technical and other resources. The Company expects its competitors to continue to improve the performance of their current products. These competitors have stated that they will introduce new products with improved price and performance characteristics that will compete directly with the Company's products. This could cause a decline in sales or loss of market acceptance of the Company's steppers, and thereby materially adversely affect the Company's business, financial condition and results of operations. There can be no assurance that enhancements to, or future generations of, competing products will not be developed that offer superior cost of ownership and technical performance features. The Company believes that to be competitive, it will require significant financial resources in order to continue to invest in new product development, features and enhancements, to introduce next generation stepper systems on a timely basis, and to maintain customer service and support centers worldwide. In marketing its products, the Company may also face competition from vendors employing other technologies. In addition, increased competitive pressure has led to intensified price-based competition, resulting in lower prices and margins. This pressure has been caused, in part, from the relative weakness of the Japanese yen versus the U.S. dollar and the current cyclical downturn in both the semiconductor and thin film head industries. Should these competitive trends continue, the Company's business, financial condition and operating results would continue to be materially adversely affected. There can be no assurance that the Company will be able to compete successfully in the future. Foreign IC manufacturers have a significant share of the worldwide market for certain types of ICs for which the Company's systems are used. However, the Japanese stepper manufacturers are well established in the Japanese stepper market, and it is extremely difficult for non-Japanese lithography equipment companies to penetrate the Japanese stepper market. To date, the Company has not established itself as a major competitor in the Japanese equipment market and there can be no assurance that the Company will be able to achieve significant sales to Japanese manufacturers in the future. (See "International Sales; Japanese Market"). DEVELOPMENT OF NEW PRODUCT LINES; EXPANSION OF OPERATIONS; ASSIMILATION OF ACQUIRED PRODUCT LINES Currently, the Company is devoting significant resources to the development, introduction and commercialization of new products and technologies that are outside the Company's core businesses. During the remainder of 1999, the Company will continue to develop these products and will continue to incur significant operating expenses in the areas of research, development and engineering and general and administrative costs in order to further develop and support these new products. Additionally, gross profit margins and inventory levels may be further adversely impacted in the future by costs associated with the initial production of these new product lines. These costs include, but are not limited to, additional manufacturing overhead, additional inventory write-offs, costs associated with managing multiple sites and the establishment of additional after-sales support organizations. Additionally, there can be no assurance that operating expenses will not increase, relative to sales, as a result of adding additional marketing and administrative personnel, among other costs, to support the 18 Company's new products. If the Company is unable to achieve significantly increased net sales or its sales fall below expectations, the Company's operating results will be materially adversely affected until, among other factors, costs and expenses can be reduced. On June 11, 1998, the Company completed the acquisition of substantially all of the assets and the assumption of certain liabilities of ISI, a privately held manufacturer of i-line and DUV reduction lithography systems (the "Acquisition"). Acquisitions involve numerous risks, including difficulties in the assimilation of the operations, technologies and products of the acquired companies; diversion of management's attention from other business concerns; risks of entering markets in which the Company has no or limited direct experience; and the potential loss of key employees of the acquired company. In the event the Company acquires product lines, technologies or businesses which do not complement the Company's business, or which otherwise do not enhance the Company's sales or operating results, the Company may incur substantial write-offs and higher recurring operating costs, which could have a material adverse effect on the Company's business, financial condition and results of operations. Accordingly, there can be no assurance as to the effect of the Acquisition on the Company's business, financial condition or operating results. In conjunction with the Acquisition, significant intangible assets were acquired. The creation of additional intangible assets has the impact of increasing amortization expense, which may continue to have a material adverse affect on the Company's results of operations should significant sales for these newly acquired product lines not materialize. The Company has purchased significant levels of plant and equipment for the anticipated volume production of the UltraBeam "V" Model electron beam lithography system. To date, the Company has shipped one UltraBeam system to a customer. The Company believes that any future success of this product line is dependent, in large part, on the Company's ability to further develop this system and the customers' ability to integrate this highly technical product into their existing processes. In December 1997, the Company terminated its distributor relationship with Innotech, its Japan distributor. The Company expanded its operations in Japan during 1998, by establishing a direct sales force, leasing additional facilities and by making significant capital expenditures for sales and applications support. Should additional gross profit on sales to the Japan marketplace not be sufficient to fund these expanded operations, the Company's business, financial condition and results of operations would be materially adversely affected. LENGTHY SALES CYCLE Sales of the Company's systems depend, in significant part, upon the decision of a prospective customer to increase manufacturing capacity or to restructure current manufacturing facilities, either of which typically involves a significant commitment of capital. In view of the significant investment involved in a system purchase, the Company has experienced and may continue to experience delays following initial qualification of the Company's systems as a result of delays in a customer's approval process. For this and other reasons, the Company's systems typically have a lengthy sales cycle during which the Company may expend substantial funds and management effort in securing a sale. Lengthy sales cycles subject the Company to a number of significant risks, including inventory obsolescence and fluctuations in operating results, over which the Company has little or no control. CUSTOMER CONCENTRATION Historically, the Company has sold a substantial portion of its systems to a limited number of customers. Sales to one customer accounted for approximately 25% and 14% of the Company's net sales in 1998 and 1997, respectively. Additionally, in 1997, a second customer accounted for approximately 10% of the Company's net sales. The Company expects that sales to relatively few customers will continue to account for a high percentage of its net sales in the foreseeable future and believes that the Company's financial results depend in significant part upon the success of these major customers, and the Company's ability to meet their future capital equipment needs. Although the composition of the group comprising the Company's largest customers may vary from period to period, the loss of a significant customer or any reduction in orders by any significant customer, including reductions due to market, economic or competitive conditions in the semiconductor or magnetic recording head industries or in the industries that manufacture products utilizing integrated circuits or thin film heads, may have a material adverse effect on the Company's business, financial 19 condition and results of operations. The Company's ability to maintain or increase its sales in the future will depend, in part, upon its ability to obtain orders from new customers as well as the financial condition and success of its customers and the general economy, of which there can be no assurance. (See "Cyclicality of Semiconductor and Thin Film Head Industries"). In addition to the business risks associated with the dependence on these major customers, these significant customer concentrations have in the past resulted, and currently result in significant concentrations of accounts receivable and leases receivable. In particular, sales to a relatively few customers in the thin film head industry currently make up a significant portion of the Company's leases receivable. The formation of significant and concentrated long-term receivables exposes the Company to additional risks, including the risk of default by one or more customers representing a significant portion of the Company's total receivables. During the three month periods ended September 30 and December 31, 1998, the Company recorded significant reserves against its trade accounts receivable and leases receivable. If additional lease and accounts receivable reserves were to be required, the Company's business, financial condition and results of operations would be materially adversely affected. IMPORTANCE OF MIX-AND-MATCH STRATEGY A principal element of the Company's strategy has been to sell its 1X lithography systems to advanced semiconductor fabrication facilities for mix-and-match applications. This strategy depends, in significant part, upon the recognition by semiconductor manufacturers that costs can be reduced by using the Company's systems to perform exposure on semiconductor process layers requiring feature sizes of 0.65 microns or greater and the willingness of such manufacturers to implement processes to lower manufacturing costs. Many semiconductor fabrication facilities have limited or no experience with integrating lithography tools in the manner necessary for full implementation and acceptance of a mix-and-match manufacturing strategy, and there can be no assurance that semiconductor manufacturers will adopt such a strategy. The Company has designed certain of its systems to operate in a compatible manner with its i-line and DUV reduction steppers and its competitors' reduction steppers and step-and-scan systems, which are used to process layers with feature sizes below 0.65 microns. The successful implementation of the Company's strategy, however, will result in a loss of sales by manufacturers of reduction steppers and will cause these competitors to respond with lower prices, productivity improvements or new technical designs for their systems that may eliminate the need for the Company's steppers or make it difficult for the Company's systems to attain compatibility with such systems. Also, certain of the Company's competitors, which also manufacture widefield systems, including Nikon and Canon, are shipping their own widefield mix-and-match lithography systems. The introduction, development and sales of such competitive systems could materially adversely affect the Company's business, financial condition and results of operations. To facilitate its mix-and-match strategy, the Company has developed and is continuing to develop a family of products. In 1995, the Company commenced shipment and volume production of the Titan Wafer Stepper and commenced shipment of the Saturn Wafer Stepper. Additionally, during 1997 the Company added multiple versions of its Titan and Saturn wafer steppers in order to more fully address the needs of the mix-and-match market. As is typical with newly introduced systems in the capital equipment industry, the Company has experienced and may continue to experience technical or other difficulties with its mix-and-match family of products. The Company believes that the market acceptance and process verification combined with volume production of the mix-and-match family of products is of critical importance to the successful implementation of its mix-and-match strategy and its future financial results. Recently, this market segment of the Company's business has experienced a pronounced downturn due, in part, to the recent cyclical downturn in the semiconductor industry and the strength of the U.S. dollar in relationship to the Japanese yen. Additionally, the Company believes that existing capital budgets of semiconductor manufacturers are currently focusing on technology buys, and not capacity additions. This places the Company at a disadvantage, since its steppers address non-critical geometries. To the extent that the mix-and-match family of products does not achieve or maintain significant sales due to a continued cyclical downturn in the semiconductor industry; technical, manufacturing or other difficulties associated with these products; lack of customer acceptance; an 20 inability to reduce the significantly long manufacturing cycle of these products; an inability to increase capacity for the production of the mix-and-match family of products; direct competition from other widefield mix-and-match and i-line step-and-scan systems from Nikon, Canon, and ASML, among others; or any other reason, the Company's business, financial condition and results of operations would be materially adversely affected. In addition, the increase in mix-and-match stepper production has resulted and will continue to result in higher inventory levels and operating expenses. Failure to achieve or maintain significant sales of these steppers has led and could continue to lead, among other things, to an increase in inventory obsolescence and an increase in expenses without corresponding sales, both of which have and could continue to have a material adverse affect on the Company's business, financial condition and results of operations. RAPID TECHNOLOGICAL CHANGE; IMPORTANCE OF TIMELY PRODUCT INTRODUCTION The semiconductor and magnetic recording head manufacturing industries are subject to rapid technological change and new product introductions and enhancements. The Company's ability to be competitive in these and other markets will depend, in part, upon its ability to develop new and enhanced systems and related software tools, and to introduce these systems and related software tools at competitive prices and on a timely and cost-effective basis to enable customers to integrate them into their operations either prior to or as they begin volume product manufacturing. The Company will also be required to enhance the performance of its existing systems and related software tools. Any success of the Company in developing new and enhanced systems and related software tools depends upon a variety of factors, including product selection, timely and efficient completion of product design, timely and efficient implementation of manufacturing and assembly processes, product performance in the field and effective sales and marketing. In particular, the Company has not yet fully defined the markets and applications for the Titan Wafer Stepper Family and the Saturn Wafer Stepper Family and is in the process of assimilating the product lines acquired from ISI. Because new product development commitments must be made well in advance of sales, new product decisions must anticipate both future demand and the technology that will be available to supply that demand. There can be no assurance that the Company will be successful in selecting, developing, manufacturing and marketing new products and related software tools or enhancing its existing products and related software tools. Any such failure would materially adversely affect the Company's business, financial condition and results of operations. Because of the large number of components in the Company's systems, significant delays can occur between a system's introduction and the commencement by the Company of volume production of such systems. The Company has experienced delays from time to time in the introduction of, and technical and manufacturing difficulties with, certain of its systems and enhancements and related software tools and may experience delays and technical and manufacturing difficulties in future introductions or volume production of new systems or enhancements and related software tools. In particular, the Company has very little experience in manufacturing its UltraBeam electron beam lithography system. Due to the significant manufacturing cycle time required for the production of this system, its lengthy sales cycle, lack of adequate documentation for the product and the complex nature of this system, delays in production and/or shipment have resulted and will continue to result from time to time. Due to the high selling price of this system, delays in shipments from one quarter to the next would have a material adverse effect on the results of operations for that quarter. Additionally, the Company is in the process of assimilating the operations acquired in the Acquisition and developing related marketing and product development plans. This has resulted and could continue to result in a delay of any eventual volume production of the products acquired. (See "Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). There can be no assurance that the Company will not encounter additional technical, manufacturing or other difficulties that could further delay future introductions or volume production of systems or enhancements. The Company's inability to complete the development or meet the technical specifications of any of its systems or enhancements and related software tools, or its inability to manufacture and ship these systems or enhancements and related software tools in volume and in time to meet the requirements for manufacturing the future generation of semiconductor or thin film head 21 devices would materially adversely affect the Company's business, financial condition and results of operations. In addition, the Company may incur substantial unanticipated costs to ensure the functionality and reliability of its products early in the products' life cycles. If new products have reliability or quality problems, reduced orders or higher manufacturing costs, delays in collecting accounts receivable and additional service and warranty expenses may result. Any of such events may materially adversely affect the Company's business, financial condition and results of operations. INTERNATIONAL SALES; JAPANESE MARKET International sales accounted for approximately 47% and 33% of total net sales for the years 1998 and 1997, respectively. The Company anticipates that international sales, which typically have lower gross margins than domestic sales, principally due to higher field service and support costs, will continue to account for a significant portion of total net sales. As a result, a significant portion of the Company's sales will continue to be subject to certain risks, including unexpected changes in regulatory requirements, difficulty in satisfying existing regulatory requirements, exchange rate fluctuations, tariffs and other barriers, political and economic instability, difficulties in accounts receivable collections, natural disasters, difficulties in staffing and managing foreign subsidiary and branch operations and potentially adverse tax consequences. Although the Company generally transacts its international sales in U.S. dollars, international sales expose the Company to a number of additional risk factors, including fluctuations in the value of local currencies relative to the U.S. dollar, which, in turn, impact the relative cost of ownership of the Company's products and may further impact the purchasing ability of its international customers. In Japan, however, the Company's orders are typically denominated in Japanese yen. This may subject the Company to a higher degree of risk from currency fluctuations. The Company attempts to mitigate this exposure through the use of foreign exchange contracts. The Company is also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of semiconductors and magnetic recording head products. The Company cannot predict whether quotas, duties, taxes or other charges or restrictions will be implemented by the United States, Japan or any other country upon the importation or exportation of the Company's products in the future. There can be no assurance that any of these factors or the adoption of restrictive policies will not have a material adverse effect on the Company's business, financial condition and results of operations. Additionally, the Company believes that the severe currency and equity market fluctuations that have been experienced recently by many of the Asian markets have resulted, and may continue to result, in delays, deferrals and cancellations of orders of the Company's products, particularly in the short-term, which will have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company has sold a number of its systems to Japanese thin film head manufacturers, to date, the Company has made limited sales of its systems to Japanese semiconductor manufacturers. The Japanese semiconductor market segment is large, represents a substantial percentage of the worldwide semiconductor manufacturing capacity, and is difficult for foreign companies to penetrate. The Company is at a competitive disadvantage with respect to Japanese semiconductor capital equipment suppliers that have been engaged for some time in collaborative efforts with Japanese semiconductor manufacturers, and currently dominate the Japanese stepper market. The Company believes that increased penetration of the Japanese market is critical to its financial results and intends to continue to invest significant resources in Japan in order to meet this objective. As part of its strategy to penetrate the Japanese market, in 1993, the Company entered into a distribution agreement with Innotech Corporation, a local distributor of products. This agreement was terminated in December 1997, and the Company expanded its operations in Japan during 1998 by establishing a direct sales force and creating sales and applications support organizations. (See "Additional Risk Factors: Development of New Product Lines; Expansion of Operations; Assimilation of Acquired Product Lines"). INTELLECTUAL PROPERTY RIGHTS Although the Company attempts to protect its intellectual property rights through patents, copyrights, trade secrets and other measures, it believes that any success will depend more upon the innovation, technological expertise and marketing abilities of its employees. Nevertheless, the Company has a policy of seeking patents when appropriate on inventions resulting 22 from its ongoing research and development and manufacturing activities. The Company owns various United States and foreign patents, which expire on dates ranging from July 2000 to February 2017, and has various United States and foreign patent applications pending. The Company also has various registered trademarks and copyright registrations covering mainly software programs used in the operation of its stepper systems. The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that the Company will be able to protect its technology adequately or that competitors will not be able to develop similar technology independently. There can be no assurance that any of the Company's pending patent applications will be issued or that foreign intellectual property laws will protect the Company's intellectual property rights. In addition, litigation may be necessary to enforce the Company's patents, copyrights or other intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations, regardless of the outcome of the litigation. There can be no assurance that any patent issued to the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to the Company. Furthermore, there can be no assurance that others will not independently develop similar products, duplicate the Company's products or, if patents are issued to the Company, design around the patents issued to the Company. Although there are no pending lawsuits against the Company regarding infringement claims with respect to any existing patent or any other intellectual property right, the Company has from time to time been notified of claims that it may be infringing intellectual property rights possessed by third parties. Certain of the Company's customers have received notices of infringement from Technivision Corporation and the Lemelson Medical, Education and Research Foundation, Limited Partnership alleging that the manufacture of certain semiconductor products and/or the equipment used to manufacture those semiconductor products infringes certain issued patents. The Company has been notified by certain of such customers that the Company may be obligated to defend or settle claims that the Company's products infringe any of such patents and, in the event it is subsequently determined that the customer infringes any of such patents, they intend to seek reimbursement from the Company for damages and other expenses resulting from this matter. Although there are no pending lawsuits against the Company regarding infringement claims with respect to any existing patents or any other intellectual property rights, there can be no assurance that infringement claims by third parties or claims for indemnification resulting from infringement claims in the future will not be asserted, or that such assertions, if proven to be true, will not materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of any litigation. With respect to any such future claims, the Company may seek to obtain a license under the third party's intellectual property rights. There can be no assurance, however, that a license will be available on reasonable terms or at all. The Company could decide, in the alternative, to resort to litigation to challenge such claims. Such challenges could be extremely expensive and time consuming and could materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of any litigation. SOLE OR LIMITED SOURCES OF SUPPLY The Company procures certain of its critical systems' components, subassemblies and services from a single supplier or a limited group of suppliers in order to ensure overall quality and timeliness of delivery. To date, the Company has been able to obtain adequate services and supplies of components and subassemblies for its systems in a timely manner. However, disruption or termination of certain of these sources, due to year 2000 compliance issues or other factors, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is relying increasingly on outside vendors to manufacture certain components of its products. The Company's reliance on sole or a limited group of suppliers and the Company's increasing reliance on subcontractors involve several risks, including a potential inability to obtain an adequate supply of required components due to the suppliers' failure or inability to provide such components in a timely manner, or at all, and reduced control over pricing and timely delivery of 23 components. Although the timeliness, yield and quality of deliveries to date from the Company's subcontractors have been acceptable, manufacture of certain of these components and subassemblies is an extremely complex process, and long lead-times are required. Any inability to obtain adequate deliveries or any other circumstance that would require the Company to seek alternative sources of supply or to manufacture such components internally could delay the Company's ability to ship its products, which could damage relationships with current and prospective customers and therefore would have a material adverse effect on the Company's business, financial condition and results of operations. (See "Year 2000 Readiness Disclosure"). DEPENDENCE ON KEY PERSONNEL The Company's future operating results depend, in significant part, upon the continued contributions of key personnel, many of whom would be difficult to replace. None of such persons has an employment or noncompetition agreement with the Company. The Company does not maintain any life insurance on any of its key persons. The loss of key personnel could have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, the Company's future operating results depend in significant part upon its ability to attract and retain other qualified management, manufacturing, and technical, sales and support personnel for its operations. There are only a limited number of persons with the requisite skills to serve in these positions and it may become increasingly difficult for the Company to hire such personnel over time. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting or retaining such personnel. The failure to attract or retain such persons would materially adversely affect the Company's business, financial condition and results of operations. During the last several years, the Company has experienced an increased level of employee turnover. The Company believes that this increase has been due to several factors, including: the continued semiconductor industry slowdown, which resulted in planned reductions in the Company's workforce during the fourth fiscal quarter of 1996 and the third fiscal quarter of 1998, and which has further resulted in an increased level of uncertainty within the workforce; an expanding economy within the geographic area that the Company maintains its principal business offices, making it more difficult for the Company to retain its employees; and the declining value of stock options granted to employees, relative to their total compensation, as a result of the full vesting of options granted prior to the Company's initial public offering and significant numbers of options granted at prices well in excess of the current market value of the Company's stock. Additionally, the Company has implemented various cost-saving measures, including additional scheduled plant shutdowns and required time-off for its employees. Due to these and other factors, the Company may continue to experience high levels of employee turnover, which could adversely affect the Company's business, financial condition and results of operations. EFFECTS OF CERTAIN ANTI-TAKEOVER PROVISIONS Certain provisions of the Company's Certificate of Incorporation, equity incentive plans, Shareholder Rights Plan, Bylaws and Delaware law may discourage certain transactions involving a change in control of the Company. In addition to the foregoing, the Company's classified board of directors, the shareholdings of the Company's officers, directors and persons or entities that may be deemed affiliates and the ability of the Board of Directors to issue "blank check" preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a change in control of the Company and may adversely affect the voting and other rights of holders of Common Stock. VOLATILITY OF STOCK PRICE The Company believes that factors such as announcements of developments related to the Company's business, fluctuations in the Company's operating results, sales of securities of the Company into the marketplace, general conditions in the semiconductor and magnetic recording head industries or the worldwide or regional economies, an outbreak of hostilities, a shortfall in revenue or earnings from, or changes, in analysts' expectations, announcements of technological innovations or new products or enhancements by the Company or its competitors, developments in patents or other intellectual property rights and developments in the Company's relationships with its customers and suppliers could cause the price of the Company's Common Stock to fluctuate, perhaps substantially. In addition, in recent years the stock market in general, and the market for shares of small capitalization stocks in particular, including the Company's, have experienced 24 extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. There can be no assurance that the market price of the Company's Common Stock will not continue to experience significant fluctuations in the future, including fluctuations that may be unrelated to the Company's performance. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and to the subheading "Derivative instruments and hedging" in Item 8, "Financial Statements and Supplementary Data", under the heading "Notes to Consolidated Financial Statement" of the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 25 PART 2: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 5. OTHER INFORMATION. Mr. Daniel Berry has been promoted to the position of President. His current title is President and Chief Operating Officer of Ultratech Stepper. Additionally, Mr. Larry Thompson has been promoted to the position of President of UltraBeam Lithography. Both Mr. Berry and Mr. Thompson report to Mr. Arthur Zafiropoulo, Chairman and CEO of Ultratech Stepper, Inc. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit 27 Financial Data Schedule (b) REPORTS ON FORM 8-K The Company did not file any reports on Form 8-K during the three months ended March 31, 1999. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ULTRATECH STEPPER, INC. - -------------------------------------------------------------------------------- (Registrant) Date: May 14, 1999 By: /s/William G. Leunis, III ---------------- ------------------------------------------------- William G. Leunis, III Senior Vice President Finance and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) 27 EX-27 2 EX-27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ULTRATECH STEPPER INC., FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000909791 ULTRATECH 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 63,666 81,129 12,148 2,292 30,750 192,555 46,370 24,095 235,730 28,735 0 0 0 21 206,643 235,730 21,640 25,779 13,949 17,058 6,537 97 121 (2,529) 0 (2,529) 0 0 0 (2,529) (0.12) (0.12)
-----END PRIVACY-ENHANCED MESSAGE-----