PART I
SPEEDFAM INTERNATIONAL INC (SFAM) Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEGMENTS
The Company's total revenue consists of net sales in two segments: (i) equipment, parts and expendables, and (ii) slurries, as well as commissions earned on the distribution in the U.S. and Europe of products produced by SpeedFam Co., Ltd. (the "Far East Joint Venture").
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of earnings data for the periods indicated as a percentage of total revenue:
Three Months Ended Nine Months Ended
February 28, February 28,
---------------- ----------------
1999 1998 1999 1998
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Revenue:
Net sales 97.6% 97.2% 98.4% 96.3%
Commissions from affiliate 2.4 2.8 1.6 3.7
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Total revenue 100.0 100.0 100.0 100.0
Cost of sales 66.6 58.6 66.6 57.3
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Gross margin 33.4 41.4 33.4 42.7
Research, development and engineering 23.3 15.9 29.0 14.1
Selling, general and administrative 29.6 18.0 27.1 16.9
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Operating profit (loss) (19.5) 7.5 (22.7) 11.7
Other income, net 5.2 3.3 5.6 2.4
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Earnings (loss) from consolidated companies
before income taxes (14.3) 10.8 (17.1) 14.1
Income tax expense (benefit) (7.2) 3.8 (8.7) 5.0
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Earnings (loss) from consolidated companies (7.1) 7.0 (8.4) 9.1
Equity in net earnings of affiliates 0.7 3.6 1.7 2.4
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Net earnings (loss) (6.4)% 10.6% (6.7)% 11.5%
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Net Sales. The Company's net sales for the third quarter of fiscal 1999 were $31.3 million, down 33.4% from net sales of $47.0 million for the corresponding period in the prior year. Sales of equipment, parts and expendables decreased to $25.5 million or 81.6% of net sales in the third quarter of fiscal 1999, against $40.9 million or 87.0% of net sales in the same period of fiscal 1998. The sales decline in this segment was primarily attributable to lower sales of the Company's CMP systems to the semiconductor industry. Sales of CMP systems generated $19.1 million, or 61.1% of net sales in the third quarter of fiscal 1999, down from the $28.0 million, or 59.5% of net sales, reported a year earlier. The Company's net sales in this quarter were affected by the continued worldwide slowdown in overall demand for semiconductor manufacturing equipment, including CMP systems, which is due to the over-capacity situation in the semiconductor device market worldwide. In addition, the Company has experienced increased competition in the sales of CMP systems to semiconductor manufacturers currently making equipment buying decisions. The Company believes that these market uncertainties will likely have an adverse effect on sales of CMP systems, as well as other equipment products the Company sells, through the next 12 to 18 months.
Sales to the thin film memory disk market in the third quarter of fiscal 1999 accounted for $6.1 million, or 19.5% of net sales, compared with $13.0 million, or 27.0% of net sales, for the third quarter of fiscal 1998. The technology of thin film memory disks has shifted to the use of alternative substrates (e.g.,glass), and a majority of those substrates are being produced by Far East manufacturers. Consequently, thin film memory disk manufacturers in the United States have experienced manufacturing over-capacity which in turn has reduced capital spending for equipment the Company supplies from its U.S. operations. The Company expects these manufacturing over-capacity problems to continue in the U.S. at least
through the next 12 months.
Net sales for the nine months ended February 28, 1999 were $91.0 million, down 40.5% against net sales of $152.8 million in the first nine months of fiscal 1998. A decline in sales of CMP equipment accounted for the significant portion of this sales decline. In the first nine months of fiscal 1999, sales of CMP systems were $53.2 million, or 58.5% of net sales, compared to $93.4 million or 61.1% of net sales, reported a year earlier. In addition, net sales in the nine months ended February 28, 1999 decreased due to a decline in sales to the thin film memory disk market. In the nine months ended February 28, 1999, sales to the thin film memory disk market were $19.5 million compared to $42.5 million in the same nine months of the prior year. Equipment sales to the thin film memory disk market have declined
during this period due to the reasons set forth above.
The decrease in net sales in the three and nine months ended February 28, 1999 was also attributable to a decrease in sales of slurries. Slurries revenue decreased to $5.8 million or 18.4% of net sales in the third quarter of fiscal 1999 from $6.1 million or 13.0% in the comparable period of fiscal 1998. In the first nine months of fiscal 1999, sales of slurries were $17.2 million or 18.9% of net sales compared to the $22.2 million or 14.5% in the same period of fiscal 1998.
Commissions from Affiliate. Commissions from affiliate decreased to $781,000 during the third quarter of fiscal 1999 from $1.4 million in the corresponding period of fiscal 1998. During the first nine months
of this fiscal year, commissions from affiliate decreased to $1.5 from $5.9 million in the first nine months of fiscal 1998. The decline in commission revenue in the three and nine months ended February 28, 1999 was due to the continued slowdown in demand for capital equipment primarily from the silicon wafer market and, to a lesser extent, the thin film memory disk industry. The Company believes that capital equipment spending will continue to be weak in the thin film memory and silicon wafer industries through the next 12 months, in turn further lowering commissions from affiliate compared to prior year periods.
Gross Margin. Gross margin decreased to $10.7 million or 33.4% of total revenue for the three months ended February 28, 1999 from $20.0 million or 41.4% of total revenue for the three months ended
February 28, 1998. For the first nine months of fiscal 1999, gross margin was $30.9 million or 33.4% of total revenue, compared to $67.8 million or 42.7% of total revenue in fiscal 1998. Gross margin, both in dollars and as a percentage of total revenue, was down year over year primarily due to higher material costs for the Company's mainline CMP tool, the Auriga-C integrated dry-in/dry-out system, higher overhead costs due to excess production capacity, lower commission revenue, pricing pressure in all markets, and shifts in the product mix.
Research, Development and Engineering. Research, development and engineering expense was $7.5 million or 23.3% of total revenue in the third quarter of fiscal 1999, down slightly from $7.7 million or 15.9%
of total revenue in the third quarter of fiscal 1998. In the nine months ended February 28, 1999, research, development and engineering expense increased to $26.9 million or 29.0% of total revenue compared to $22.4 million or 14.1% of total revenue in the same period of fiscal year 1998. Research, development and engineering expense in the three month period ended February 28, 1999, was comparable to the prior year. However, the increase in the nine month period of fiscal 1999 ended February 28, 1999 from the same period in fiscal 1998 is a result of the Company continuing to invest significant amounts of money in its CMP systems' reliability and productivity improvements, various process technologies for the semiconductor device market and growing its technical support organization due to the greater number of the Company's CMP systems now in the field worldwide. The Company will continue to make significant investments in research, development and engineering to maintain
technological competitiveness and meet the process requirements of its customers. Research, development and engineering expense as a percentage of total revenue increased substantially due to reduced
revenues in fiscal 1999.
Selling, General and Administrative. In the third quarter of fiscal 1999, selling, general and administrative expense was $9.5 million, or 29.6% of total revenue, up from $8.7 million, or 18.0%, last year. Selling, general and administrative expense decreased to $25.0 million or 27.1% of total revenue in the first nine months of fiscal 1999 from $26.8 million or 16.9% of total revenue in the first nine months of fiscal 1998. The dollar increase in the third quarter of fiscal 1999 as compared to the prior year was due to higher commissions paid to the Far East Joint Venture as a result of increased sales of CMP systems manufactured in the United States and sold into the Asian markets. Selling, general and administrative expense declined in the first nine months of fiscal 1999 from fiscal 1998 due to management's efforts to control expenses to align them with lower revenue expectations, including decreased travel, an across the board reduction in all management salaries, a freeze on new hires, and
reductions in the Company's global workforce. Selling, general and administrative expense as a percentage of total revenue increased substantially in both the three and nine month periods ended February 28,1999. This was primarily due to reduced revenues in fiscal 1999.
Other Income, Net. At $1.6 million, other income in the third quarter of fiscal 1999 was level with that recorded in the third quarter of fiscal 1998. Other income increased to $5.2 million in the first nine
months of fiscal 1999 from $3.9 million in the comparable period of fiscal 1998. Other income consisted almost entirely of interest income in the third quarter of fiscal 1999. Interest income increased in the
first nine months of fiscal 1999 compared to the prior year period as a result of the cash infusion from the Company's equity offering in October 1997, as well as, a change in investment strategy to higher
yielding taxable investments in the first quarter of fiscal 1999.
Income Tax Benefit. In the third quarter and first nine months of fiscal 1999, the Company provided for a tax benefit due to the operating losses reported. The tax benefit has been recorded at a rate
significantly above the federal benefit rate of 35% due to the impact of significant research and development tax credits.
Equity in Net Earnings of Affiliates. The Company's equity in the net earnings of its joint ventures was $211,000 for the third quarter, compared to $1.7 million a year ago. For the first nine months of fiscal 1999, equity in net earnings of affiliates decreased to $1.6 million from $3.8 million in the corresponding period in the prior year. The Company believes that the earnings of the Company's largest
joint venture, the Far East Joint Venture, may be adversely affected for at least the next 12 months by both the slow down in demand for equipment sold into the thin film memory disk and silicon wafer
markets, as well as current economic challenges facing many Far East economies.
LIQUIDITY AND CAPITAL RESOURCES
As of February 28, 1999, the Company had $108.4 million in cash, cash equivalents and short-term investments, compared to $141.2 million at May 31, 1998. The Company used $10.6 million of net cash in
operating activities. Cash from operations was used primarily to pay down accounts payable and amounts due to affiliates, reduce other current liabilities and increase accounts receivable and other current
assets.
Accounts payable and due to affiliates decreased to $15.5 million at February 28, 1999, from $23.9 million at May 31, 1998. This decrease was a result of management's ongoing efforts to control inventory
purchasing in anticipation of lower sales volume in the first nine months of fiscal year 1999. Cash used in operations was partially offset by reductions in inventories.
Accounts receivable increased to $47.0 million at February 28, 1999, from $45.2 million at May 31, 1998. The small increase in accounts receivable was primarily due to the effects of extended payment
terms on sales of equipment to certain customers in fiscal 1999.
Inventory decreased to $38.5 at February 28, 1999, from $55.5 million at May 31, 1998. Inventory had increased substantially in fiscal year 1998 due to a build up of CMP systems in the third and fourth quarters of fiscal 1998, which did not ship until the first and second quarters of fiscal year 1999. In addition, inventories decreased due to decreased production in anticipation of lower sales volume in fiscal year 1999. SpeedFam established an obsolescence reserve for inventories at February 28, 1999 and May 31, 1998, respectively.
The Company made capital expenditures of $24.3 million in the first nine months of fiscal 1999. The majority of the cash was used to fund the construction of a new 109,000 square foot Technology Center
next to its corporate headquarters in Chandler, Arizona. Through the nine months ended February 28, 1999, short-term investments of the Company matured or were sold providing cash of $75.9 million. Sales of short-term investments also provided $35.8 million in cash. In total, $46.3 million in cash was invested in short-term securities in the nine months ended February 28, 1999.
Financing activities provided $2.1 million in cash, primarily through the sale of stock to employees and the exercise of stock options. In response to the merger with IPEC, the Company's new management believed its combined financial resources allowed it to reduce its bank lines of credit. Consequently, the Company has terminated its $60.0 million credit facility, and is replacing it with a new $25.0 million secured revolving line of credit. The Company also has a pound sterling 950,000 ($1.6 million) revolving credit facility with the London branch of a U.S. bank. As of April 6, 1999, no amounts were outstanding on any loan facility. The Company believes that the Company's cash, cash equivalents and short-term investments combined with the available proceeds from available loan facilities will be sufficient to meet the Company's capital requirements during at least the next 12 months.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" is effective for financial years beginning after June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The Company is valuating the new Statement's provisions and has not yet determined its impact. The Company will adopt SFAS No. 133 effective June 1, 2000.
RECENT DEVELOPMENTS
On April 6, 1999, the shareholders and stockholders of the Company and Integrated Process Equipment Corp. ("IPEC"), respectively, approved the merger agreement between these two companies. The Company's shareholders also approved an amendment to the Company's Articles of Incorporation changing the name of the Company to SpeedFam-IPEC, Inc. Under the terms of the merger agreement entered into on November 19, 1998, each share of IPEC common stock was exchanged for 0.71 shares of
the Company's common stock. The Company expects to issue approximately 13,048,540 shares of the Company's common stock to IPEC stockholders.
The Company has incurred and will incur substantial expenses to complete the merger, including estimated costs of approximately $6.5 million for financial accounting and legal advisors and for the
special meetings of shareholders.
The Company is evaluating its strategic alternatives to increase the profitability of the Company. These strategies relate to work force reductions, discontinuing product lines and eliminating duplicate
facilities. The Company expects that these strategies will result in recoverability issues for certain assets. The Company expects to incur in the fourth quarter of its fiscal year 1999, which ends May 31,
1999, a charge for severance costs, inventory adjustments and asset impairments related to discontinued products lines, cancellations of real estate leases and other merger expenses totaling an estimated $50
to $70 million. Additional costs presently unknown may also negatively impact the results of operations following the merger.
YEAR 2000
The Company has addressed the issues associated with the programming code in existing computer systems as the millennium (Year 2000) approaches. The Year 2000 computer software problem is pervasive and complex, as virtually every computer operation will be affected in some way. The Company is aware of and is addressing the potential computing difficulties that may be triggered by the Year 2000 problem.
The Company has substantially completed a Year 2000 date review and conversion project to address all the necessary changes, testing and implementation issues. The project encompassed three major areas of
review: internal systems (hardware and software), supplier compliance and Company products. The Company has identified the changes required to its computer programs and hardware. The necessary modifications to the Company's centralized financial, manufacturing and operational information systems have been completed. The Company's major suppliers have been sent letters requesting information regarding their own Year 2000 plan, as well as requesting confirmation that the components supplied by these vendors are Year 2000 compliant. The Company has evaluated the vendor responses which have been received and concluded that the vendors which have responded either are Year 2000 compliant or are proceeding with their own Year 2000 compliance programs. The Company will continue to follow-up with vendors with which the Company has a material relationship and who have not responded to obtain
assurances that they expect to be Year 2000 compliant in time. Equipment and systems manufactured and supplied by the Company have been evaluated and determined to be free of any material problems
that could be caused by the Year 2000 issue. Management estimates that the Company's remaining Year 2000 compliance expense will be immaterial. The Company believes that Year 2000 problems related to
its own internal systems and equipment and systems it sells have been addressed and resolved and will not have a material effect on the Company's business, financial condition and results of operations. However, there can be no assurance that the systems of other companies upon which the Company's systems and business rely will be timely converted or that any such failure to convert by another company would not have a material adverse effect on the Company's business, financial conditions or results of operations. To mitigate this risk, the Company is reviewing its vendor relationships and building alternative sources of supply should the business operations of any one vendor be interrupted due to the Year 2000 problems.
CERTAIN FACTORS AFFECTING THE COMPANY'S BUSINESS
Discussed below are certain factors which may affect the Company's business. This discussion is not exclusive of other factors that may also affect the Company's business and should be read in conjunction
with the other information contained in this Form 10-Q including, without limitation, information provided in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
RISKS RELATED TO THE MERGER WITH IPEC
IF THE COMPANY DOES NOT INTEGRATE THE TECHNOLOGY AND OPERATIONS OF THE
COMPANY AND IPEC QUICKLY AND EFFECTIVELY, THE POTENTIAL BENEFITS OF THE RECENT MERGER MAY NOT OCCUR. Achieving the merger's potential benefits will require the Company to reduce excess personnel and redundant facilities and equipment. Management's choices in this regard may not prove optimal in the long term. In addition, the Company must integrate all components of the Company's and IPEC's previously individual operations, including the following:
- Sales and marketing operations, including international distribution channels. Prior to the merger, internationally, the Company distributed its products through a direct sales force while IPEC used
distributors. Combining international sales channels could result in expense or customer confusion.
- Product offerings, including marketing of products to the other's customers.
- Research and development programs.
- Manufacturing operations and philosophies. Prior to the merger, the Company assembled components purchased from multiple vendors, while IPEC manufactured many of its products' components and purchased others from vendors.
- Field service support for CMP equipment.
- Management information and reporting systems. Since the Company and IPEC used different management information systems, the Company may face difficulties obtaining timely and accurate information, data and reports to operate the combined Company effectively until integration is completed.
The Company cannot be certain that it can achieve integration of these components without adversely impacting operations. To the extent management focuses on integration, it may not be able to develop the
business.
SUBSTANTIAL EXPENSES RESULTING FROM THE MERGER. The Company has incurred, and will incur, substantial expenses to complete the merger, including estimated costs of approximately $6.5 million for financial, accounting and legal advisors and for the special meetings of shareholders.
The Company is evaluating its strategic alternatives to increase the profitability of the Company. These strategies relate to work force reductions, discontinuing product lines and eliminating duplicate
facilities. The Company expects that these strategies will result in recoverability issues for certain assets. The Company expects to incur in the fourth quarter of its fiscal year 1999, which ends May 31,
1999, a charge for severance costs, inventory adjustments and asset impairments related to discontinued products lines, cancellations of real estate leases and other merger expenses totaling an estimated $50
to $70 million. Additional costs presently unknown may also negatively impact the results of operations following the merger.
THE MERGER MAY RESULT IN A LOSS OF KEY EMPLOYEES. The Company's success following the merger depends on retaining and integrating the Company and IPEC personnel. The Company has signed agreements with a few key IPEC employees to retain their services. However, Company employees may leave for many reasons, including:
- As integration proceeds, the Company anticipates eliminating excess personnel in many functional areas. Other employees may leave for varied reasons, such as increased workloads or the mistaken assumption
that the individual's job will be terminated.
- New and different corporate culture. Prior to the merger, the Company and IPEC had different corporate cultures. IPEC's employees had greater autonomy than in the Company's organization, which
emphasized, and continues to emphasize, more centralized planning and control methods.
- Competition for qualified personnel in the industry served by the Company, particularly in the Phoenix metropolitan area, is intense. The Company and IPEC had experienced difficulty in attracting qualified personnel in the past. The Company expects to experience the same difficulty in the future.
- Competitors may continue to recruit employees during integration. This is common in mergers in the technology industry.
RISKS RELATED TO BUSINESS OPERATIONS
THE COMPANY'S GROWTH DEPENDS ON CONTINUED AND INCREASED ACCEPTANCE OF CMP AMONG SEMICONDUCTOR MANUFACTURERS. While CMP is used by a number of advanced logic semiconductor manufacturers, CMP has been used to manufacture advanced memory devices only in the
past 2 years. Continued and increased acceptance of CMP systems depends on many factors considered by potential customers, including the CMP product's:
- Cost of ownership
- Throughput
- Process flexibility
- Performance, including reliability
- Customer support
Failure to adequately meet potential customers' needs with respect to one or more of these factors will result in decreased acceptance of CMP and, therefore, the Company's CMP systems, which will in turn
negatively impact the Company's profitability.
THE COMPANY MAY NOT DEVELOP PRODUCTS IN TIME TO MEET CHANGING
TECHNOLOGIES.
Semiconductor manufacturing equipment and processes are subject to rapid technological changes and product obsolescence. Developing new products in the rapidly evolving industry in which the Company
operates involves a number of risks:
- Products may be introduced behind schedule or after customers have made buying decisions.
- Products may not be accepted in the marketplace.
After the merger, competitive pressures will require the Company to continue to develop or enhance products, including both the copper and dual damascene processes, end-point detection metrology, post-CMP cleaning and a 300 mm CMP system to address current and future needs of semiconductor manufacturers. The Company will also continue to develop products and processes for thin film memory disk manufacturers and to enhance the plasma-assisted chemical etch processes.
PRODUCT OR PROCESS DEVELOPMENT PROBLEMS COULD HARM THE COMPANY'S RESULTS OF OPERATIONS. The company's products are complex, and from time to time have defects or "bugs" that are difficult and costly to fix. This can harm results of operations for the company in two ways:
- The company incurs substantial costs to ensure the functionality and reliability of products earlier in their life cycle. This can reduce orders, increase manufacturing costs, adversely impact working capital
and increase service and warranty expenses.
- The company requires significant lead-times between product introduction and commercial shipment. As a result, the company may have to write off inventory and other assets related to products and could lose customers and revenue.
THE CURRENT SLOWDOWN IN THE SEMICONDUCTOR INDUSTRY CONTINUES TO
NEGATIVELY IMPACT THE COMPANY'S PROFITABILITY. The Company is currently experiencing a slowdown in product demand and volatility in product pricing for the following reasons:
- The cyclical nature of the semiconductor industry
- General over-capacity of customers
- The financial crisis in Asia
This slowdown has reduced the revenue to the Company in recent periods. The Company believes that the slowdown will continue to negatively impact revenue performance for at least the next 12 to 18 months. Despite the slowdown, however, the Company will continue to invest in research and development and customer support to remain competitive. This will result in reduced profitability for the Company.
BOTH THE COMPANY AND IPEC HAD LOSSES PRIOR TO THE MERGER AND THE COMPANY EXPECTS LOSSES IN THE NEAR FUTURE. The Company had net losses of $2.1 million in the quarter ended February 28, 1999, $4.3 million in the quarter ended November 30, 1998, and $5.5 million in the quarter ended May 31, 1998. The Company did not have a net loss for the quarter ended August 31, 1998, but did have an operating loss of $3.5 million. IPEC had net losses of $16.1 million in the quarter
ended March 31, 1999, $14.0 million in the quarter ended December 31, 1998, and $10.1 million in the quarter ended September 30, 1998. These losses were primarily the result of the slowdown in the industry combined with increasing investment in research and development. The Company currently believes it will continue to experience losses as long as the industry slowdown continues.
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