10-Q 1 d10q.txt FORM 10-Q ________________________________________________________________________________ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 31, 2001 OR [_] 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 0-22366 CREDENCE SYSTEMS CORPORATION (Exact name of registrant as specified in its charter) Delaware 94-2878499 (State or other jurisdiction) (IRS Employer of incorporation or organization) Identification No.) 215 Fourier Ave., Fremont, California 94539 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (510) 657-7400 ________________________________________________________________________________ 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 Sections 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 [_] APPLICABLE ONLY TO CORPORATE ISSUERS: At September 7, 2001, there were approximately 60,114,383 shares of the Registrant's common stock, $0.001 par value per share, outstanding. ________________________________________________________________________________ 1 CREDENCE SYSTEMS CORPORATION
INDEX PAGE NO. ----- PART I. FINANCIAL INFORMATION Item 1. Financial Statements ............................................................ 3 Condensed Consolidated Balance Sheets ........................................... 3 Condensed Consolidated Statements of Operations ................................. 4 Condensed Consolidated Statements of Cash Flows ................................. 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 ...................... 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................................... 25 Item 2. Changes in Securities ........................................................... 25 Item 3. Defaults Upon Senior Securities ................................................. 25 Item 4. Submission of Matters to a Vote of Securityholders ............................. 25 Item 5. Other Information ............................................................... 25 Item 6. Exhibits and Reports on Form 8-K ................................................ 25
2 PART I - FINANCIAL INFORMATION Item I - Financial Statements CREDENCE SYSTEMS CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
July 31, October 31, 2001 2000/a/ -------------- --------------- (unaudited) ASSETS Current assets: Cash and cash equivalents ......................... $ 40,416 $ 119,089 Short-term investments ............................ 57,559 124,545 Accounts receivable, net .......................... 45,138 175,794 Inventories ....................................... 144,431 102,034 Other current assets .............................. 53,442 29,420 --------- ---------- Total current assets ............................ 340,986 550,882 Long-term investments ............................... 202,211 133,804 Property and equipment, net ......................... 104,501 94,853 Goodwill from acquisitions, net ..................... 54,487 55,133 Other intangible assets, net ........................ 41,316 42,161 Other assets ........................................ 8,675 2,404 --------- ---------- Total assets .................................... $ 752,176 $ 879,237 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable .................................. $ 22,527 $ 53,287 Accrued liabilities ............................... 41,008 71,202 Income taxes payable .............................. -- 23,866 --------- ---------- Total current liabilities ....................... 63,535 148,355 Other liabilities ................................... 9,874 8,332 Minority interest ................................... 231 323 Stockholders' equity ................................ 678,536 722,227 --------- ---------- Total liabilities and stockholders' equity ...... $ 752,176 $ 879,237 ========= ==========
See accompanying notes. a) Derived from the audited consolidated balance sheet included in the Company's Form 10-K for the year ended October 31, 2000. 3 CREDENCE SYSTEMS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (unaudited)
Three Months Ended Nine Months Ended July 31, July 31, ------------------------------- ------------------------------- 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Net sales .................................................. $ 18,762 $ 204,000 $ 185,232 $ 459,522 Cost of goods sold - on net sales .......................... 14,659 80,765 89,653 186,584 Cost of goods sold - special charges ....................... -- -- 45,020 -- ---------- --------- ---------- --------- Gross margin ............................................... 4,103 123,235 50,559 272,938 Operating expenses: Research and development ................................ 19,330 19,490 57,763 48,176 Selling, general and administrative ..................... 17,076 29,885 65,536 74,120 Amortization of purchased intangibles ................... 5,987 3,360 17,280 5,491 Acquired in-process research and development ............ -- 8,282 -- 8,282 Special charges ......................................... 2,705 -- 4,673 -- ---------- --------- ---------- --------- Total operating expenses ............................ 45,098 61,017 145,252 136,069 ---------- --------- ---------- --------- Operating income (loss) .................................... (40,995) 62,218 (94,693) 136,869 Interest and other income, net ............................. 4,061 5,874 12,933 9,366 ---------- --------- ---------- --------- Income (loss) before income tax provision (benefit) ........ (36,934) 68,092 (81,760) 146,235 Income tax provision (benefit) ............................. (14,562) 27,113 (30,251) 54,853 Minority interest (benefit) ................................ 67 (18) (93) 29 ---------- --------- ---------- --------- Net income (loss) .......................................... ($22,439) $ 40,997 ($51,416) $ 91,353 ========== ========= ========== ========= Net income (loss) per share Basic ................................................... ($0.43) $ 0.82 ($0.98) $ 1.94 ========== ========= ========== ========= Diluted ................................................. ($0.43) $ 0.74 ($0.98) $ 1.75 ========== ========= ========== ========= Number of shares used in computing per share amount Basic ................................................... 52,723 49,802 52,542 47,200 ========== ========= ========== ========= Diluted ................................................. 52,723 55,101 52,542 52,079 ========== ========= ========== =========
See accompanying notes. 4 CREDENCE SYSTEMS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Increase (decrease) in cash and cash equivalents (unaudited, in thousands)
Nine Months Ended July 31, ---------------------- 2001 2000 --------- --------- Cash flows from operating activities: Net income (loss) .............................................................. ($ 51,416) $ 91,353 Adjustments to reconcile net income (loss) to net cash used in operating activity Depreciation and amortization ............................................... 39,231 22,972 Non cash special charges .................................................... 47,407 -- (Gain) loss on disposal of property and equipment ........................... 1,410 (1,156) Minority interest ........................................................... (92) 29 Changes in operating assets and liabilities: Accounts receivable, inventories and other current assets ................ 17,278 (128,480) Accounts payable, accrued liabilities and income taxes payable ........... (82,365) 51,887 --------- --------- Net cash provided by (used in) operating activities ................... (28,547) 36,605 Cash flows from investing activities: Purchases of available-for-sale securities ..................................... (194,841) (241,081) Maturities of available-for-sale short-term securities ......................... 39,150 33,792 Sales of available-for-sale securities ......................................... 156,555 17,612 Acquisition of property and equipment .......................................... (30,665) (20,664) Purchases of intangible assets and other assets ................................ (22,061) (47,398) Proceeds from sale of property and equipment ................................... 315 2,188 --------- --------- Net cash used in investing activities .................................... (51,547) (255,551) Cash flows from financing activities: Issuance of common & treasury stock ............................................ 7,906 300,340 Repurchase of common stock ..................................................... (6,485) -- --------- --------- Net cash provided by financing activities ................................ 1,421 300,340 --------- --------- Net increase (decrease) in cash and cash equivalents .............................. (78,673) 81,394 Cash and cash equivalents at beginning of period .................................. 119,089 52,104 --------- --------- Cash and cash equivalents at end of period ........................................ $ 40,416 $ 133,498 ========= ========= Supplemental disclosures of cash flow information: Interest paid .................................................................. $ 541 $ 2,536 Income taxes paid .............................................................. $ 17,459 $ 38,447 Noncash activities: Net transfers of inventory to property and equipment ........................... $ 2,765 $ 5,501 Income tax benefit from employee stock activity ................................ $ 1,738 $ 7,964 Issuance of common or treasury stock for convertible subordinated notes ........ $ -- $ 589 Exchange of convertible sub. notes for common stock plus issuance costs ........ $ -- $ (589)
See accompanying notes. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Quarterly Financial Statements The condensed consolidated financial statements and related notes for the three and nine months ended July 31, 2001 and 2000 are unaudited but include all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations of the Company for the interim periods. The results of operations for the three and nine months ended July 31, 2001 and 2000 were not necessarily indicative of the operating results to be expected for the full fiscal year. The information included in this report should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the fiscal year ended October 31, 2000 included in the Company's most recent Annual Report on Form 10-K and the additional risk factors contained herein and therein, including, without limitation, risks relating to successful integration of acquisitions, fluctuations in our quarterly net sales and operating results, limited systems sales, backlog, cyclicality of semiconductor industry, management of fluctuations in our operating results, expansion of our product lines, limited sources of supply, reliance on our subcontractors, highly competitive industry, rapid technological change, importance of timely product introduction, customer concentration, lengthy sales cycle, changes in financial accounting standards and accounting estimates, dependence on key personnel, international sales, proprietary rights, future capital needs, leverage, volatility of our stock price and effects of certain anti-takeover provisions, as set forth in this Report. Any party interested in reviewing a free copy of the Form 10-K or the Company's other publicly available documents should write to the Chief Financial Officer of the Company. USE OF ESTIMATES - The preparation of the accompanying unaudited condensed consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. BASIS OF PRESENTATION - Certain prior year amounts in the Condensed Consolidated Financial Statements and related notes have been reclassified to conform to the current year's presentation. 2. Inventories Inventories are stated at the lower of standard cost (which approximates first-in, first-out cost) or market. Inventories consist of the following (in thousands): July 31, October 31, 2001 2000 -------- -------- (unaudited) Raw materials ................. $ 77,971 $ 39,736 Work-in-process ............... 25,365 44,704 Finished goods ................ 41,095 17,594 -------- -------- $144,431 $102,034 ======== ======== 3. Net Income (Loss) Per Share Basic net income (loss) per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is based upon the weighted average number of common shares and dilutive-potential common shares outstanding during the period. Options to purchase approximately 10,606,541 shares at an average price of $19.98 per share were outstanding at July 31, 2001, but were not included in the computation of diluted net loss per share because options are anti-dilutive in periods when the Company incurs a net loss. The following table sets forth the computation of basic and dilutive net income (loss) per share (in thousands, except per share amounts): 6
Three Months Ended Nine Months Ended July 31, July 31, -------- -------- -------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Numerator: Numerator for basic and diluted net income (loss) per share- net income (loss) ............................................. ($22,439) $ 40,997 ($51,416) $ 91,353 -------- -------- -------- -------- Denominator: Denominator for basic net income (loss) per share- weighted-average shares ....................................... 52,723 49,802 52,542 47,200 Effect of dilutive securities-employee stock options .......... -- 3,648 -- 3,650 Effect of dilutive securities-subordinated convertible notes .. -- 1,651 -- 1,230 -------- -------- -------- -------- Denominator for diluted earnings per share-adjusted weighted-average shares and assumed conversions .................. 52,723 55,101 52,542 52,079 -------- -------- -------- -------- Basic net income (loss) per share .............................. ($0.43) $ 0.82 ($0.98) $ 1.94 ======== ======== ======== ======== Diluted net income (loss) per share ............................ ($0.43) $ 0.74 ($0.98) $ 1.75 ======== ======== ======== ========
4. Recent Accounting Pronouncements In November 2000, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," (SFAS 133). SFAS 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Adoption of SFAS 133 did not have a material impact on the Company's financial condition or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial Statements". SAB 101 provides guidance on the recognition, presentation, and disclosure of revenue in financial statements. All registrants are expected to apply the accounting principles and disclosure described in SAB 101. Because the Company has complied with generally accepted accounting principles for its historical revenue recognition, the change in its revenue policy resulting from SAB 101 will be reported as a cumulative effect adjustment resulting from a change in accounting principle effective November 1, 2000, in the fourth quarter of fiscal 2001. Adoption of SAB 101 will also require the Company to re-state the quarterly results for the three fiscal quarters ended July 31, 2001. The Company is currently in the process of assessing SAB 101 and how it will impact its reported revenues and income and is therefore unable to determine the impact of SAB 101 on its financial statements. 5. Contingencies The Company is involved in various claims arising in the ordinary course of business, none of which, in the opinion of management, if determined adversely against the Company, would have a material adverse effect on the Company's business, financial condition or results of operations. We have at times been notified that we may be infringing intellectual property rights of third parties and we have litigated patent infringement claims in the past. We expect to continue to receive notice of such claims in the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing that certain of our products are infringing a patent held by inTEST. We have since then engaged in sporadic discussions with inTEST concerning this matter. On December 15, 2000, inTEST filed a complaint in the U.S. District Court for the District of Delaware against us, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001, the Company was served with the complaint. We may also be obligated to other third parties relating to 7 this allegation. We believe we have meritorious defenses to the claims. However, we cannot be certain of success in defending this patent infringement claim or claims for indemnification resulting from infringement claims and that it will not have a material impact. 6. Special Charges Operations for the three month period ended July 31, 2001 included a pre-tax charge of approximately $1.7 million related to fees and expenses associated with the recent acquisition of Integrated Measurement Systems, Inc. ("IMS") as well as a pre-tax charge of approximately $1.0 million for severance payments and asset disposals associated with the Company's continuing headcount reductions. Operations for the nine month period ended July 31, 2001 included the above items as well as a pre-tax charge of approximately $45.0 million related to a provision for excess inventory and a pre-tax charge of approximately $2.0 million for severance payments and asset disposals associated with the Company's continuing headcount reductions. 7. Accumulated Other Comprehensive Income (Loss) Accumulated other comprehensive income (loss) and changes thereto consist of: Fiscal Years Nine Months Ended Ended July 31, October 31, -------------- --------------- 2001 2000 -------------- --------------- Beginning balance gain (loss) $ 2,217 $ (661) Unrealized gain on available- for-sale securities 446 3,158 Currency translation adjustment 1,839 (280) -------------- ------------- Total $ 4,502 $ 2,217 ============== ============= 8. Acquisition, Subsequent Events On August 1, 2001, Credence completed the previously announced acquisition of Oregon-based IMS for approximately $155 million in a stock-for-stock transaction. Each share of IMS common stock was converted into 0.90 shares of Credence common stock. Approximately 7.2 million shares of Credence common stock were issued in the acquisition. The acquisition will be accounted for as a pooling of interests transaction. IMS, located in Beaverton, Oregon, specializes in the design, manufacture, and marketing of high performance integrated circuit validation systems used to test, at the prototype stage, complex digital, mixed-signal and memory devices. IMS was founded in 1983 and currently has approximately 300 employees. The Company expects to record a special charge of approximately $12 to $17 million in the fourth fiscal quarter for this transaction. Approximately $7 million of that amount will consist of cash transaction expenses and the remaining portion will be related to facility closures, asset disposals and conforming accounting policies. On August 14, 2001 the board of directors, in accordance with the pooling of interests accounting on the IMS transaction, suspended the treasury stock purchase program previously announced in September 2000. 8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations In addition to the historical information contained in this document, the discussion in this Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this Report on Form 10-Q should be read as being applicable to all related forward-looking statements whenever they appear in this Report on Form 10-Q. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include those discussed below as well as those cautionary statements and other factors set forth in "Risk Factors" and elsewhere herein. Revenue growth has slowed in the first nine months of fiscal 2001 in the test and assembly sector of the semiconductor equipment industry during what we believe is a cyclical downturn in the industry. There is uncertainty as to if and when the next cyclical growth phase will occur. Until such time as we return to a growth period, we expect a continuing decline in orders and therefore expect that the October 31, 2001 fiscal quarter's revenue will be flat or decline from the levels experienced by us during the third quarter of fiscal 2001. The following table sets forth items from the Condensed Consolidated Statements of Operations as a percentage of net sales for the periods indicated:
Three Months Ended Nine Months Ended July 31, July 31, --------------------------------------------------------------- 2001 2000 2001 2000 ------------ ------------- ------------ ------------ Net sales 100.0% 100.0% 100.0% 100.0% Cost of goods sold - on net sales 78.1 39.6 48.4 40.6 Cost of goods sold - special charges -- 24.3 ----------- ------------ ----------- ----------- Gross margin 21.9 60.4 27.3 59.4 Operating expenses Research and development 103.0 9.6 31.2 10.5 Selling, general and administrative 91.0 14.6 35.4 16.1 Amortization of purchased intangible assets 31.9 1.6 9.3 1.2 Acquired in-process research and development -- 4.1 -- 1.8 Special charges 14.4 -- 2.5 -- ----------- ------------ ----------- ----------- Operating expenses 240.4 29.9 78.4 29.6 ----------- ------------ ----------- ----------- Operating income (loss) (218.5) 30.5 (51.1) 29.8 Interest and other income 21.6 2.9 7.0 2.0 ----------- ------------ ----------- ----------- Income (loss) before income tax provision (benefit) 196.9) 33.4 (44.1) 31.8 Income tax provision (benefit) (77.3) 13.3 (16.3) 11.9 ----------- ------------ ----------- ----------- Net income (loss) (119.6) 20.1 (27.8) 19.9 =========== ============ =========== ===========
RESULTS OF OPERATIONS NET SALES Net sales consist of revenues from systems sales, spare parts sales, maintenance contracts and software sales. Net sales were $18.8 million for the third quarter of fiscal 2001, representing a decrease of 90.8% from the net sales of $204.0 million in the comparable third quarter of fiscal 2000. Net sales declined 56.7% from the second quarter of fiscal 2001, when the Company recorded $43.3 million in revenue. During fiscal years 1999 and 2000, our net sales improved each sequential quarter because of four principal factors: 9 . a significant increase in the worldwide demand for semiconductor ATE; . improved business and economic conditions in Asia, particularly in Taiwan; . the increased sales of two major products: the Quartet high-performance mixed signal tester and the Kalos memory tester; and . the acquisition of the TMT, Inc. ("TMT") product lines in May 2000. Since October 2000, revenue has declined in each fiscal quarter of 2001 in the test and assembly sector of the semiconductor equipment industry during what is now believed to be a cyclical downturn in the industry. This belief is based on weakening order activity, order cancellations, and customer-requested shipment delays from our existing backlog. This business weakness is being experienced throughout the industry with particularly strong declines in Asia. International net sales accounted for approximately 73%, 80%, and 64% of total net sales in the first nine months of fiscal 2001 and fiscal years 2000 and 1999, respectively. Our net sales to the Asia-Pacific region accounted for approximately 46%, 69% and 55% of total net sales in the first nine months of fiscal 2001 and fiscal years 2000 and 1999, respectively, and thus are subject to the risk of economic instability in that region that materially adversely affected the demand for our products in 1998. Capital markets in Korea and other areas of Asia have been highly volatile, resulting in economic instabilities. These instabilities may reoccur, which could materially adversely affect demand for our products. Our net sales by product line in the first nine months of fiscal 2001 and fiscal years 2000 and 1999 consisted of:
Nine Months Fiscal Years Ended Ended July 31, October 31, ----------------- ---------------------- 2001 2000 1999 ----------------- ---------- ---------- Mixed-Signal 64% 72% 65% Logic 5 12 16 Memory 16 11 7 Service and software 15 5 12 ---------------- --------- --------- Total 100% 100% 100% ================ ========= =========
The increase in the memory percentage and the high percentage of net sales attributable to mixed-signal products are principally derived from the sales of the Kalos and Quartet products, respectively. Revenues from software were not material to our operations in the first nine months of 2001 and fiscal years 2000 and 1999, representing less than 4% of our net sales in each period. GROSS MARGIN Our gross margin has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, pricing by competitors or suppliers, new product introductions, product sales mix, production volume, customization and reconfiguration of systems, international and domestic sales mix and field service margins. Our gross margins for the third quarter and the first nine months of fiscal 2001 were impacted by declining manufacturing volumes and charges for excess inventories made in the second fiscal quarter. During the second quarter of fiscal 2001, we recorded approximately $45.0 million of special charges related to the write down of excess inventory and purchase commitment liabilities, of which approximately $19 million was related to the logic product lines with the rest largely earmarked for the mixed signal product lines. Our gross margin (excluding these charges), was 21.9% and 51.6% for the three and nine month periods ended July 31, 2001, respectively, compared with 60.4% and 59.4% for the comparable periods in fiscal 2000. The falling gross margins are the results of higher costs caused by under-absorption of largely fixed manufacturing expenses as well as lower average selling prices in fiscal 2001. 10 RESEARCH AND DEVELOPMENT Research and development ("R&D") expenses were $57.7 million in the first nine months of fiscal 2001, an increase of $9.6 million or 19.9% over the same period of fiscal 2000. The higher level of spending in fiscal 2001 reflects the acquisitions of TMT and Modulation Instruments, Inc. ("MI") in fiscal 2000 as well as increases in internal R&D project expenses. As a percentage of net sales, R&D expenses were 31.2% for the first nine months of fiscal 2001, an increase from 10.5% in the first nine months of fiscal 2000. We currently intend to continue to invest significant resources in the development of new products and enhancements of existing products for the foreseeable future. Accordingly, we expect these expenses to be relatively stable in absolute dollars for the remainder of fiscal 2001. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses ("SG&A") were $65.5 million in the first nine months of fiscal 2001, representing an $8.6 million, or 11.6%, decrease from the comparable period of fiscal 2000. The lower spending in 2001 was primarily due to decreased payroll and commission related expenses due to a lower headcount and lower sales levels in fiscal 2001. As a percentage of net sales, SG&A expenses were 35.4% for the first nine months of fiscal 2001, compared with 16.1% for the corresponding period in fiscal 2000. We expect SG&A expenses for the remainder of fiscal 2001 to decline slightly in absolute dollars because of the headcount reductions effected in February, May and August 2001, as well as other cost saving measures. AMORTIZATION OF PURCHASED INTANGIBLES Amortization of purchased intangible expenses increased to $17.3 million in the first nine months of fiscal 2001 from $5.5 million in the comparable period of fiscal 2000, an increase of 215%. In May 2000, we purchased TMT for approximately $80.0 million, in August 2000 we purchased MI for approximately $20.5 million and Credence Europa for approximately $8.4 million, in October 2000 we purchased NewMillennia Solutions, Inc. for approximately $11.3 million, and earlier this calendar year we purchased Dimensions Consulting, Inc. ("DCI") and certain assets of Rich Rabkin & Associates, Inc ("Rabkin") for approximately $13.9 million. These acquisitions have resulted in approximately $5.9 million in quarterly charges for amortization of purchased intangibles assets. SPECIAL CHARGES In the second quarter of fiscal 2001, we recorded approximately $47 million of special charges as a result of a major downturn in the semiconductor equipment industry. In the third quarter we recorded $2.7 million of special charges. The recent headcount reductions have reduced our worldwide headcount from approximately 1,450 at October 31, 2000 to 1,080 today. In addition we have instituted a reduced work schedule and implemented pay cuts for our remaining employees. We recorded a special charge in the second fiscal quarter for costs of goods sold of approximately $45 million related to the write down of excess inventories. Approximately $19 million of this charge is for our logic product lines and is principally for raw materials and work in process. The remaining $26 million is primarily for the mixed signal product lines and is principally for raw materials, work in process and purchase commitment liabilities. With the dramatic decline in revenue during this downturn, the Company continues to monitor its inventory levels in light of product development changes and expectations of an eventual upturn. The Company may be required to take additional charges for excess and obsolete inventories as we better understand the impact of these events on our current inventory levels. We recorded a special operating charge of approximately $2 million in the second fiscal quarter and $1 million in the third fiscal quarter for severance payments and asset disposals associated with our recent headcount reductions. Approximately $2.1 million was for severance payments and the rest of the charge was for asset disposals. The cash expenditures associated with these charges largely occurred in the first nine months of this fiscal year with the remaining amounts expected to be paid in the fourth fiscal quarter of 2001. We recorded a special operating charge of approximately $1.7 million for transaction related expenses for the IMS acquisition in the third fiscal quarter of 2001. The Company expects to record a special charge of approximately $12 to $17 million in the fourth fiscal quarter related to the closing of this transaction. Approximately $7 million of 11 that amount will consist of cash transaction expenses and the remaining portion will be related to facility closures, asset disposals and conforming accounting policies. INTEREST AND OTHER INCOME (EXPENSES), NET We generated net interest and other income of $12.9 million for the first nine months of fiscal 2001, as compared to $9.4 million for the first nine months of fiscal 2000. The increase in fiscal 2001 was due to higher average cash and investment balances in fiscal 2001 as compared to fiscal 2000. These higher average balances were the result of the cash received in our secondary public offering in February 2000 offset by cash outlays for acquisitions and the purchase of our Hillsboro, Oregon facility. In addition, in September 2000, we called for redemption of our remaining outstanding Convertible Subordinated Notes. INCOME TAXES Our estimated effective tax benefit rate for the first nine months of fiscal 2001 was 37.0%, compared to an effective tax rate of 35.5% in the first nine months of fiscal 2000. The estimated tax benefit rate for fiscal 2001 is less than the combined federal and state statutory rate primarily due to the impact of non-deductible goodwill amortization. The effective tax rate in fiscal 2000 was less than the combined federal and state statutory rate primarily due to the benefits of our foreign sales corporation. The tax rate applied to pre-tax book income for the first nine months is computed based on a projected effective tax rate for the year. LIQUIDITY AND CAPITAL RESOURCES Operating activities used a net cash flow of $28.5 million and provided a net cash flow of $36.6 million for the nine months ended July 31, 2001 and 2000, respectively. Net cash flows used by operating activities for the first nine months of fiscal 2001 were primarily due to net income before special non-cash charges and depreciation and amortization of $35.2 million offset by an increase in working capital of $65.1 million. Investing activities used net cash flows of approximately $51.5 million and $255.6 million in the nine months ended July 31, 2001 and 2000, respectively. For fiscal 2001, approximately $0.9 million was used for net purchases of available-for-sale securities, $30.7 million for purchases of property and equipment to support our business, and we disbursed approximately $13 million for the acquisition of DCI and the assets of Rabkin. We also provided a $5 million dollar loan in the form of a note receivable to our independent leasing associate during the first half of fiscal 2001. Financing activities provided net cash flows of $1.4 million and $300.3 million for the nine months ended July 31, 2001 and 2000, respectively. The net cash flows provided for the first nine months of fiscal 2001 were primarily from the issuance of common stock through our employee equity plans offset by the repurchase of 325,000 shares of our common stock for $6.5 million. As of July 31, 2001, we had working capital of approximately $277.5 million, including cash and short-term investments of $98.0 million, and accounts receivable and inventories representing $189.6 million. We expect our receivables to continue to represent a significant portion of working capital. We believe that because of the relatively long manufacturing cycles of many of our testers and the new products we have and plan to continue to introduce, investments in inventories will also continue to represent a significant portion of working capital. Significant investments in accounts receivable and inventories may subject us to increased risks which could materially adversely affect our business, financial condition and results of operations. Total current liabilities of $63.5 million as of July 31, 2001 decreased from $148.4 million as of October 31, 2000. Our principal sources of liquidity as of July 31, 2001 consisted of approximately $40.4 million of cash and cash equivalents, and short-term investments of $57.6 million. In addition, we had $202.2 million of available-for-sale securities, classified as long-term investments at July 31, 2001. 12 RECENT ACCOUNTING PRONOUNCEMENTS In November 2000, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," (SFAS 133). SFAS 133 requires us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in the fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Adoption of SFAS 133 did not have a material impact on our financial condition or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial Statements". SAB 101 provides guidance on the recognition, presentation, and disclosure of revenue in financial statements. All registrants are expected to apply the accounting principles and disclosure described in SAB 101. Because we have complied with generally accepted accounting principles for our historical revenue recognition, the change in our revenue policy resulting from SAB 101 will be reported as a cumulative effect adjustment resulting from a change in accounting principle effective November 1, 2000, in the fourth quarter of fiscal 2001. Adoption of SAB 101 will also require us to restate our quarterly results for the three fiscal quarters ended July 31, 2001. We are currently in the process of assessing SAB 101 and how it will impact our reported revenues and income and we are, therefore, unable to determine the impact of SAB 101 on our financial statements. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of fiscal 2003. Application of the nonamortization provisions of the Statement is expected to result in an increase in net income of approximately $10 million per year. During fiscal 2003, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of November 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company. 13 RISK FACTORS Our operating results may fluctuate significantly which may adversely affect our stock price [GRAPH] A variety of factors affect our results of operations. The above graph illustrates that our quarterly net sales and operating results have fluctuated significantly. We believe they will continue to fluctuate for several reasons, including: . economic conditions in the semiconductor industry in general and capital equipment industry specifically; . manufacturing capacity and ability to volume produce systems, including our newest systems, and meet customer requirements; . timing of new product announcements and new product releases by us or our competitors; . market acceptance of our new products and enhanced versions of existing products; . manufacturing inefficiencies associated with the start-up of our new products, changes in our pricing or payment terms and cycles, and those of our competitors, customers and suppliers; . write-offs of excess and obsolete inventories and accounts receivable that are not collectible; . supply constraints; . patterns of capital spending by our customers, delays, cancellations or reschedulings of customer orders due to customer financial difficulties or otherwise; . changes in overhead absorption levels due to changes in the number of systems manufactured, the timing and shipment of orders, availability of components including custom ICs, subassemblies and services, customization and reconfiguration of our systems and product reliability; . expenses associated with acquisitions and alliances; . operating expense reductions associated with cyclical industry downturns, including costs relating to facilities consolidations and related expenses; . the proportion of our direct sales and sales through third parties, including distributors and OEMS, the mix of products sold, the length of manufacturing and sales cycles, and product discounts; 14 . natural disasters, political and economic instability, currency fluctuations, regulatory changes and outbreaks of hostilities; and . our ability to attract and retain qualified employees in a competitive market. We intend to introduce new products and product enhancements in the future, the timing and success of which will affect our business, financial condition and results of operations. Our gross margins on system sales have varied significantly and will continue to vary significantly based on a variety of factors including: . manufacturing inefficiencies; . pricing concessions by us and our competitors and pricing by our suppliers; . hardware and software product sales mix; . inventory write-downs; . manufacturing volumes; . new product introductions; . product reliability; . absorption levels and the rate of capacity utilization; . customization and reconfiguration of systems; . international and domestic sales mix and field service margins; and . facility relocations and closures. New and enhanced products typically have lower gross margins in the early stages of commercial introduction and production. Although we have recorded and continue to record provisions for estimated sales allowances and price adjustments, accounts receivable that might not be collectible, and product warranty costs, we cannot be certain that our estimates will be adequate. We cannot forecast with any certainty the impact of these and other factors on our sales and operating results in any future period. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Because of this difficulty in predicting future performance, our operating results may fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure to meet these expectations would likely adversely affect the market price of our common stock. In addition, our need for continued significant expenditures for research and development, marketing and other expenses for new products, capital equipment purchases and worldwide training and customer service and support will impact our sales and operations results in the future. Other significant expenditures may make it difficult for us to reduce our significant fixed expenses in a particular period if we do not meet our net sales goals for that period. These other expenditures include: . research and development; . support costs for the distribution channels; . marketing and other expenses for new products; . capital equipment purchases and world-wide training; and . customer support and service. As a result, we cannot be certain that we will be profitable in the future. 15 We have a limited backlog and obtain most of our net sales from a relatively few number of system sales transactions, which can result in fluctuations of quarterly results. Other than some memory products and software products, for which the price range is typically below $50,000, we obtain most of our net sales from the sale of a relatively few number of systems that typically range in price from $200,000 to $2.0 million. This has resulted and could continue to result in our net sales and operating results for a particular period being significantly impacted by the timing of recognition of revenue from a single transaction. Our net sales and operating results for a particular period could also be materially adversely affected if an anticipated order from just one customer is not received in time to permit shipment during that period. Backlog at the beginning of a quarter typically does not include all orders necessary to achieve our sales objectives for that quarter. Orders in backlog are subject to cancellation, delay, deferral or rescheduling by customers with limited or no penalties. In the first nine months of fiscal 2001, we experienced customer-requested shipment delays and order cancellations, and we believe it is probable that orders will be canceled in the future. Consequently, our quarterly net sales and operating results have in the past and will in the future, depend upon our obtaining orders for systems to be shipped in the same quarter in which the order is received. We believe that some of our customers may, from time to time, place orders with us for more systems than they will ultimately require, or they will order a more rapid delivery than they will ultimately require. For this reason, our backlog may include customer orders in excess of those actually delivered to them or other customers. Furthermore, we generally ship products generating most of our net sales near the end of each quarter. Accordingly, our failure to receive an anticipated order or a delay or rescheduling in a shipment near the end of a particular period may cause net sales in a particular period to fall significantly below expectations, which could have a material adverse effect on our business, financial condition or results of operations. The relatively long manufacturing cycle of many of our testers has caused and could continue to cause future shipments of testers to be delayed from one quarter to the next. Furthermore, as we and our competitors announce new products and technologies, customers may defer or cancel purchases of our existing systems. We cannot forecast the impact of these and other factors on our sales and operating results. The semiconductor industry has been cyclical Revenue growth has slowed in the test and assembly sector of the semiconductor equipment industry during what we now believe is a cyclical downturn in the industry. There is uncertainty as to if and when the next cyclical growth phase will occur. This belief is based on weakening order activity, order cancellation activity, and customer-requested shipment delays from our existing backlog. This business weakness is worldwide but we see it in particular with customers in Asia. Until such time as we return to a growth period, we expect a continuing weakness in order activity and therefore expect that the October 31, 2001 fiscal quarter's revenue will be flat or declining from the levels we experienced during the third quarter of fiscal 2001. In light of that belief, we have reduced our worldwide workforce by approximately 25%, or 370 people. We took a charge related to this reduction in force of approximately $2 million in our second fiscal quarter and another $1 million in our third fiscal quarter of 2001. Additionally, all remaining employees will be required to take five days of time off per quarter through October 31, 2001. Other initiatives, including a domestic pay cut, the consolidation and reorganization of certain functions and operations, and the curtailment of discretionary expenses, are also being implemented. If we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to any renewed growth opportunities in the future. With the dramatic decline in revenue during this downturn, the Company continues to monitor its inventory levels in light of product development changes and expectations of an eventual upturn. The Company maybe required to take additional charges for excess and obsolete inventories as we better understand the impact of these events on our current inventory levels. Our business and results of operations depend largely upon the capital expenditures of manufacturers of semiconductors and companies that specialize in contract packaging and/or testing of semiconductors. This includes manufacturers and contractors that are opening new or expanding existing fabrication facilities or upgrading existing equipment, which in turn depend upon the current and anticipated market demand for semiconductors and products incorporating semiconductors. The semiconductor industry has been highly cyclical with recurring periods of oversupply, which often has had a severe effect on the semiconductor industry's demand for test equipment, including the systems we manufacture and market. We believe that the markets for newer generations of semiconductors will also be subject to similar fluctuations. 16 We have experienced shipment delays, delays in commitments and restructured purchase orders by customers and we expect this activity to continue. Accordingly, we cannot be certain that we will be able to achieve or maintain our current or prior level of sales or rate of growth. In addition, sales are expected to be sequentially down in the next fiscal quarter and possibly in the following fiscal year. We anticipate that a significant portion of new orders may depend upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements that are not addressable by currently installed test equipment, and there can be no assurance that such demand will develop to a significant degree, or at all. In addition, our business, financial condition or results of operations may be adversely affected by any factor adversely affecting the semiconductor industry in general or particular segments within the semiconductor industry. For example, the 1997/1998 Asian financial crisis contributed to widespread uncertainty and, in part, a slowdown in the semiconductor industry. This slowdown in the semiconductor industry resulted in reduced spending for semiconductor capital equipment, including ATE which we sell. This industry slowdown had, and similar slowdowns may in the future have, a material adverse effect on our product backlog, balance sheet, financial condition and results of operations. Therefore, there can be no assurance that our operating results will not be materially adversely affected if downturns or slowdowns in the semiconductor industry occur again in the future. Over the last several years we have experienced significant fluctuations in our operating results and an increased scale of operations. In the third fiscal quarter ended July 31, 2001 our net sales fell 85% from those recorded in the first quarter of fiscal 2001 as the industry began a cyclical downturn. In fiscal 2000, we generated revenue of $101.8 million in the first quarter and $220.2 million in the fourth quarter, an increase of 116%. In fiscal 1999, we generated revenue of $26.5 million in the first quarter and $80.2 million in the fourth quarter, an increase of 203%. Since 1993, except for the current cost-cutting efforts and those during fiscal 1998 and most of fiscal 1999, we have overall significantly increased the scale of our operations in general to support periods of generally increased sales levels and expanded product offerings and have expanded operations to address critical infrastructure and other requirements, including the hiring of additional personnel, significant investments in research and development to support product development, acquisition of the new facilities in Oregon, further investments in our ERP system and numerous acquisitions. These fluctuations in our sales and operations have placed and are placing a considerable strain on our management, financial, manufacturing and other resources. In order to effectively deal with the changes brought on by the cyclical nature of the industry, we have been required to implement and improve a variety of highly flexible operating, financial and other systems, procedures and controls capable of expanding, or contracting consistent with our business. However, we cannot be certain that any existing or new systems, procedures or controls, including our ERP system, will be adequate to support fluctuations in our operations or that our systems, procedures and controls will be cost-effective or timely. Any failure to implement, improve and expand or contract such systems, procedures and controls efficiently and at a pace consistent with our business could have a material adverse effect on our business, financial condition or results of operations. We are expanding and intend to continue the expansion of our product lines. We are currently devoting and intend to continue to devote significant resources to the development, production and commercialization of new products and technologies. During fiscal 2001 we have primarily introduced products that are either evolutions of current platforms or derivative products. In the future, we expect to introduce several new products. In late fiscal 1999 and into 2000, we shipped three major new products. We invested and continue to invest significant resources in plant and equipment, leased facilities, inventory, personnel and other costs to begin or prepare to increase production of these products. A significant portion of these investments will provide the marketing, administration and after-sales service and support required for these new hardware and software products. Accordingly, we cannot be certain that gross profit margin and inventory levels will not be adversely impacted by delays in new product introductions or start-up costs associated with the initial production and installation of these new product lines. We also cannot be certain that we can manufacture these systems per the time and quantity required by our customers. The start-up costs include additional manufacturing overhead, additional inventory and warranty reserve requirements and the enhancement of after-sales service and support organizations. In addition, the increases in inventory on hand for new product development and customer support requirements have increased and will continue to increase the risk of inventory write-offs. We cannot be 17 certain that our net sales will increase or remain at recent levels or that any new products will be successfully commercialized or contribute to revenue growth or that any of our additional costs will be covered. There are limitations on our ability to find the supplies and services necessary to run our business. We obtain certain components, subassemblies and services necessary for the manufacture of our testers from a limited group of suppliers. We do not maintain long-term supply agreements with most of our vendors and we purchase most of our components and subassemblies through individual purchase orders. The manufacture of certain of our components and subassemblies is an extremely complex process. We also rely on outside vendors to manufacture certain components and subassemblies and to provide certain services. We have recently experienced and continue to experience significant reliability, quality and timeliness problems with several critical components including certain custom integrated circuits. We cannot be certain that these or other problems will not continue to occur in the future with our suppliers or outside subcontractors. Our reliance on a limited group of suppliers and on outside subcontractors involves several risks, including an inability to obtain an adequate supply of required components, subassemblies and services and reduced control over the price, timely delivery, reliability and quality of components, subassemblies and services. Shortages, delays, disruptions or terminations of the sources for these components and subassemblies have delayed and could continue to delay shipments of our systems and new products and could continue to have a material adverse effect on our business. Our continuing inability to obtain adequate yields or timely deliveries or any other circumstance that would require us to seek alternative sources of supply or to manufacture such components internally could also have a material adverse effect on our business, financial condition or results of operations. Such delays, shortages and disruptions would also damage relationships with current and prospective customers and have and could continue to allow competitors to penetrate our customer accounts. We cannot be certain that our internal manufacturing capacity or that of our suppliers and subcontractors will be sufficient to meet customer requirements. The ATE industry is intensely competitive which can adversely affect our revenue growth. With the substantial investment required to develop test application software and interfaces, we believe that once a semiconductor manufacturer has selected a particular ATE vendor's tester, the manufacturer is likely to use that tester for a majority of its testing requirements for the market life of that semiconductor and, to the extent possible, subsequent generations of similar products. As a result, once an ATE customer chooses a system for the testing of a particular device, it is difficult for competing vendors to achieve significant ATE sales to such customer for similar use. Our inability to penetrate any large ATE customer or achieve significant sales to any ATE customer could have a material adverse effect on our business, financial condition or results of operations. We face substantial competition from ATE manufacturers throughout the world, as well as several of our customers. We do not currently compete in the testing of high-end microprocessors, linear ICs or DRAMs. Moreover, a substantial portion of our net sales are derived from sales of mixed-signal testers. Many competitors have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. Certain competitors have recently introduced or announced new products with certain performance or price characteristics equal or superior to products we currently offer. These competitors have recently introduced products that compete directly against our products. We believe that if the ATE industry continues to consolidate through strategic alliances or acquisitions, we will continue to face significant additional competition from larger competitors that may offer product lines and services more complete than ours. Our competitors are continuing to improve the performance of their current products and to introduce new products, enhancements and new technologies that provide improved cost of ownership and performance characteristics. New product introductions by our competitors could cause a decline in our sales or loss of market acceptance of our existing products. Moreover, our business, financial condition or results of operations could continue to be materially adversely affected by increased competitive pressure and continued intense price-based competition. We have experienced and continue to experience significant price competition in the sale of our products. In addition, pricing pressures typically become more intense at the end of a product's life cycle and as competitors introduce more technologically advanced products. We believe that, to be competitive, we must continue to expend significant 18 financial resources in order to, among other things, invest in new product development and enhancements and to maintain customer service and support centers worldwide. We cannot be certain that we will be able to compete successfully in the future. The ATE market is subject to rapid technological change Our ability to compete in the ATE market depends upon our ability to successfully develop and introduce new hardware and software products and enhancements and related software tools with greater features on a timely and cost-effective basis, including products under development internally as well as products obtained in acquisitions. Our customers require testers and software products with additional features and higher performance and other capabilities. We are therefore required to enhance the performance and other capabilities of our existing systems and software products and related software tools. Any success we may have in developing new and enhanced systems and software products and new features to our existing systems and software products will depend upon a variety of factors, including: . product selection; . timely and efficient completion of product design; . implementation of manufacturing and assembly processes; . successful coding and debugging of software; . product performance; . reliability in the field; and . effective sales and marketing, Because we must make new product development commitments well in advance of sales, new product decisions must anticipate both future demand and the availability of technology to satisfy that demand. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new hardware and software products or enhancements and related software tools. Our inability to introduce new products and related software tools that contribute significantly to net sales, gross margins and net income would have a material adverse effect on our business, financial condition and results of operations. New product or technology introductions by our competitors could cause a decline in sales or loss of market acceptance of our existing products. In addition, if we introduce new products, existing customers may curtail purchases of the older products and delay new product purchases. Any unanticipated decline in demand for our hardware or software products could have a materially adverse effect on our business, financial condition or results of operations. Significant delays can occur between the time we introduce a system and the time we are able to produce that system in volume. We have in the past experienced significant delays in the introduction, volume production and sales of our new systems and related feature enhancements. For example, we have experienced significant delays in the introduction of our VS2000 and Kalos series testers as well as certain enhancements to our existing testers. These delays have been primarily related to our inability to successfully complete product hardware and software engineering within the time frame originally anticipated, including design errors and redesigns of ICs. As a result, some customers have experienced significant delays in receiving and using our testers in production. We cannot be certain that these or additional difficulties will not continue to arise or that delays will not continue to materially adversely affect customer relationships and future sales. Moreover, we cannot be certain that we will not encounter these or other difficulties that could delay future introductions or volume production or sales of our systems or enhancements and related software tools. We have incurred and may continue to incur substantial unanticipated costs to ensure the functionality and reliability of our testers and to increase feature sets. If our systems continue to have reliability, quality or other problems, or the market perceives our products to be feature deficient, we may suffer reduced orders, higher manufacturing costs, delays in collecting accounts receivable and higher service, support and warranty expenses, or inventory write-offs, among other effects. Our failure to have a competitive tester and related software tools available when required by a customer could make it substantially more difficult for us to sell testers 19 to that customer for a number of years. We believe that the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital, mixed signal and non-volatile memory testers are of critical importance to our future financial results. As a result, our inability to correct any technical, reliability, parts shortages or other difficulties associated with our systems or to manufacture and ship the systems on a timely basis to meet customer requirements could damage our relationships with current and prospective customers and would continue to materially adversely affect our business, financial condition and results of operations. We may not be able to deliver custom hardware options and software applications to satisfy specific customer needs in a timely manner. We must develop and deliver customized hardware and software to meet our customers' specific test requirements. The market requires us to manufacture these systems on a timely basis. Our test equipment may fail to meet our customers' technical or cost requirements and may be replaced by competitive equipment or an alternative technology solution. Our inability to meet such hardware and software requirements could impact our ability to recognize revenue on the related equipment. Our inability to provide a test system that meets requested performance criteria when required by a device manufacturer would severely damage our reputation with that customer. This loss of reputation may make it substantially more difficult for us to sell test systems to that manufacturer for a number of years. We rely on Spirox Corporation and customers in Taiwan for a significant portion of our revenues and the termination of this distribution relationship would materially adversely affect our business. Spirox Corporation, a distributor in Taiwan that sells to end-user customers in Taiwan and China, accounted for approximately 20%, 45%, and 39% of our net sales in the first nine months of fiscal 2001 and fiscal years 2000 and 1999, respectively. Our agreement with Spirox can be terminated for any reason on 90 days prior written notice. The semiconductor industry is highly concentrated, and a small number of semiconductor device manufacturers and contract assemblers account for a substantial portion of the purchases of semiconductor test equipment generally, including our test equipment. Our top ten end user customers have recently accounted for a substantial portion of our net sales. Consequently, our business, financial condition and results of operations could be materially adversely affected by the loss of or any reduction in orders by Spirox, any termination of the Spirox relationship, or any other significant customer, including the potential for reductions in orders by assembly and tester service companies which that customer may utilize or reductions due to continuing or other technical, manufacturing or reliability problems with our products or continued slow-downs in the semiconductor industry or in other industries that manufacture products utilizing semiconductors. Our ability to maintain or increase sales levels will depend upon: . our ability to obtain orders from existing and new customers; . our ability to manufacture systems on a timely and cost-effective basis; . our ability to timely complete the development of our new hardware and software products; . our customers' financial condition and success; . general economic conditions; and . our ability to meet increasingly stringent customer performance and other requirements and shipment delivery dates. Our long and variable sales cycle depends upon factors outside of our control and could cause us to expend significant time and resources prior to earning associated revenues. Sales of our systems depend in part upon the decision of semiconductor manufacturers to develop and manufacture new semiconductor devices or to increase manufacturing capacity. As a result, sales of our products are subject to a variety of factors we cannot control. The decision to purchase our products generally involves a significant commitment of capital, with the attendant delays frequently associated with significant capital expenditures. For these and other reasons, our systems have lengthy sales cycles during which we may expend substantial funds and management effort to secure a sale, subjecting us to a number of significant risks. We cannot 20 be certain that we will be able to maintain or increase net sales in the future or that we will be able to retain existing customers or attract new ones. If we engage in acquisitions, we will incur a variety of costs, and the anticipated benefits of the acquisitions may never be realized. We have developed in significant part through mergers and acquisitions of other companies and businesses. We intend in the future to pursue additional acquisitions of complementary product lines, technologies and businesses. We may have to issue debt or equity securities to pay for future acquisitions, which could be dilutive to then current stockholders. We have also incurred and may continue to incur certain liabilities or other expenses in connection with acquisitions, which have and could continue to materially adversely affect our business, financial condition and results of operations. In addition, acquisitions involve numerous other risks, including: . difficulties assimilating the operations, personnel, technologies and products of the acquired companies; . diversion of our management's attention from other business concerns; . increased complexity and costs associated with internal management structures; . risks of entering markets in which we have no or limited experience; and . the potential loss of key employees of the acquired companies. For these reasons, we cannot be certain what effect future acquisitions may have on our business, financial condition and results of operations. Changes to financial accounting standards may affect our reported results of operations. We prepare our financial statements to conform with generally accepted accounting principles, or GAAP. GAAP are subject to interpretation by the American Institute of Certified Public Accountants, the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Accounting policies affecting many other aspects of our business, including rules relating to purchase and pooling-of-interests accounting for business combinations, in-process research and development charges, revenue recognition, employee stock purchase plans and stock option grants have recently been revised or are under review. Changes to those rules or the questioning of current practices may have a material adverse effect on our reported financial results or on the way we conduct our business. For example, in the fourth quarter of fiscal 2001, we will be required to implement SAB 101 (see Note 4 of the Notes to the Condensed Consolidated Financial Statements). In addition, our preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding those estimates could result in a change to our estimates and could impact our future operating results. Our executive officers and certain key personnel are critical to our business. Our future operating results depend substantially upon the continued service of our executive officers and key personnel, none of whom are bound by an employment or non-competition agreement. Our future operating results also depend in significant part upon our ability to attract and retain qualified management, manufacturing, technical, engineering, marketing, sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these positions and it may be increasingly difficult for us to hire personnel over time. Our business, financial condition and results of operations could be materially adversely affected by the loss of any of our key employees, by the failure of any key employee to perform in his or her current position, or by 21 our inability to attract and retain skilled employees. In December 2000, our Chief Financial Officer resigned from his positions with us. In connection with his resignation, our board of directors promoted John R. Detwiler to the position of Senior Vice President of Finance, Chief Financial Officer and Secretary in February 2001. Our international business exposes us to additional risks. International sales accounted for approximately 73%, 80%, and 64% of our total net sales for the first nine months of fiscal 2001 and fiscal 2000 and 1999, respectively. As a result, we anticipate that international sales will continue to account for a significant portion of our total net sales in the foreseeable future. These international sales will continue to be subject to certain risks, including: . changes in regulatory requirements; . tariffs and other barriers; . political and economic instability; . an outbreak of hostilities; . integration and management of foreign operations of acquired businesses; . foreign currency exchange rate fluctuations; . difficulties with distributors, joint venture partners, original equipment manufacturers, foreign subsidiaries and branch operations; . potentially adverse tax consequences; and . the possibility of difficulty in accounts receivable collection. We are also subject to the risks associated with the imposition of domestic and foreign legislation and regulations relating to the import or export of semiconductor equipment and software products. We cannot predict whether the import and export of our products will be subject to quotas, duties, taxes or other charges or restrictions imposed by the United States or any other country in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations. Net sales to the Asia-Pacific region accounted for approximately 46%, 69%, and 55% of our total net sales in the first nine months of fiscal 2001 and fiscal 2000 and 1999, respectively, and thus demand for our products is subject to the risk of economic instability in that region and could continue to be materially adversely affected. Countries in the Asia-Pacific region, including Korea and Japan, have experienced weaknesses in their currency, banking and equity markets in the recent past. These weaknesses could continue to adversely affect demand for our products, the availability and supply of our product components and our consolidated results of operations. The 1997/1998 Asian financial crisis contributed to widespread uncertainty and a slowdown in the semiconductor industry. This slowdown resulted in reduced spending on semiconductor capital equipment, including ATE, and has had, and may in the future have, a material adverse effect on our product backlog, balance sheet and results of operations. Further, many of our customers in the Asia-Pacific region built up capacity in ATE during fiscal 2000 in anticipation of a steep ramp up in wafer fabrication. However, this steep ramp up in output has not fully materialized leaving some customers with excess capacity. Therefore, it is now probable that these customers will spend less in the aggregate this year than they did in fiscal 2000. One end-user customer headquartered in Europe accounted for approximately 16% of our net sales in the first nine months of fiscal 2001. In addition, one of our major distributors, Spirox Corporation, is a Taiwan-based company. This subjects a significant portion of our receivables and future revenues to the risks associated with doing business in a foreign country, including political and economic instability, currency exchange rate fluctuations and regulatory changes. Disruption of business in Asia caused by the previously mentioned factors could continue to have a material impact on our business, financial condition or results of operations. 22 If the protection of proprietary rights is inadequate, our business could be harmed. We attempt to protect our intellectual property rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. However, we cannot be certain that others will not independently develop substantially equivalent intellectual property or that we can meaningfully protect our intellectual property. Nor can we be certain that our patents will not be invalidated, deemed unenforceable, circumvented or challenged, or that the rights granted thereunder will provide us with competitive advantages, or that any of our pending or future patent applications will be issued with claims of the scope we seek, if at all. Furthermore, we cannot be certain that others will not develop similar products, duplicate our products or design around our patents, or that foreign intellectual property laws, or agreements into which we have entered will protect our intellectual property rights. Inability or failure to protect our intellectual property rights could have a material adverse effect upon our business, financial condition and results of operations. We have been involved in extensive, expensive and time-consuming reviews of, and litigation concerning, patent infringement claims. Our business may be harmed if we are found to infringe proprietary rights of others. We have at times been notified that we may be infringing intellectual property rights of third parties and we have litigated patent infringement claims in the past. We expect to continue to receive notice of such claims in the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing that certain of our products are infringing a patent held by inTEST. We have since then engaged in sporadic discussions with inTEST concerning this matter. On December 15, 2000, inTEST filed a complaint in the U.S. District Court for the District of Delaware against us, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001 we were served with the complaint. We may also be obligated to other third parties relating to this allegation. We believe we have meritorious defenses to the claims. However, we cannot be certain of success in defending this patent infringement claim or claims for indemnification resulting from infringement claims. Some of our customers have received notices from Mr. Jerome Lemelson alleging that the manufacture of semiconductor products and/or the equipment used to manufacture semiconductor products infringes certain patents issued to Mr. Lemelson. We have been notified by customers that we may be obligated to defend or settle claims that our products infringe Mr. Lemelson's patents, and that if it is determined that the customers infringe Mr. Lemelson's patents, that customers intend to seek indemnification from us for damages and other related expenses. We cannot be certain of success in defending current or future patent or other infringement claims or claims for indemnification resulting from infringement claims. Our business, financial condition and results of operations could be materially adversely affected if we must pay damages to a third party or suffer an injunction or if we expend significant amounts in defending any such action, regardless of the outcome. With respect to any claims, we may seek to obtain a license under the third party's intellectual property rights. We cannot be certain, however, that the third party will grant us a license on reasonable terms or at all. We could decide, in the alternative, to continue litigating such claims. Litigation has been and could continue to be extremely expensive and time consuming, and could materially adversely affect our business, financial condition or results of operations, regardless of the outcome. A variety of factors may cause the price of our stock to be volatile. In recent years, the stock market in general, and the market for shares of high-tech companies in particular, including ours, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. For example, in fiscal 1999, the price of our common stock ranged from a closing high of $24.94 to a closing low of $7.19. In fiscal 2000 and through September 7, 2001, the price of our common stock has ranged from a closing high of $74.59 to a closing low of $14.97. The market price of our common stock is likely to continue to fluctuate significantly in the future, including fluctuations unrelated to our performance. We believe that fluctuations of our stock price may be caused by a variety of factors, including: . announcements of developments related to our business; . fluctuations in our financial results; 23 . general conditions or developments in the semiconductor and capital equipment industry and the general economy; . sales or purchases of our common stock in the marketplace; . announcements of our technological innovations or new products or enhancements or those of our competitors; . developments in patents or other intellectual property rights; . developments in our relationships with customers and suppliers; . a shortfall or changes in revenue, gross margins or earnings or other financial results from analysts' expectations or an outbreak of hostilities or natural disasters; or . acquisition or merger activity and the success in implementing such acquisitions or other business combinations. We are subject to anti-takeover provisions that could delay or prevent an acquisition of our company. Provisions of our amended and restated certificate of incorporation, shareholders rights plan, equity incentive plans, bylaws and Delaware law may discourage transactions involving a change in corporate control. In addition to the foregoing, our classified board of directors, the stockholdings of our officers, directors and persons or entities that may be deemed affiliates, our shareholder rights plan and the ability of our board of directors to issue preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a third party to acquire us and may adversely affect the voting and other rights of holders of our common stock. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We maintain a strict investment policy which ensures the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. Our investments consist primarily of commercial paper, medium term notes, asset backed securities, US. Treasury notes and obligations of U.S. Government agencies, bank certificates of deposit, auction rate preferred securities, corporate bonds and municipal bonds. The table below presents notional amounts and related weighted-average interest rates by year of maturity for our investment portfolio (in thousands, except percent amounts):
2001 2002 2003 2004 2005 Thereafter -------- -------- -------- -------- -------- ---------- Cash Equivalents Fixed rate .......... $ 40,416 - - - - - Average rate ........ 4.47% - - - - - Short term investments Fixed rate .......... $ 16,645 $ 40,914 - - - - Average rate ........ 7.24% 6.88% - - - - Long term investments Fixed rate .......... - $ 41,007 $116,607 $28,563 - $ 16,034 Average rate ........ - 6.55% 5.82% 5.52% - 5.68% ------------------------------------------------------------------------- Total investment securities $ 57,061 $ 81,921 $116,607 $28,563 - $ 16,034 Average rate 5.28% 6.71% 5.82% 5.52% - 5.68%
We mitigate default risk by attempting to invest in high credit quality securities and by constantly positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity and maintains a prudent amount of diversification. 24 PART II. - OTHER INFORMATION Item 1. Legal Proceedings In July 1998, we received a written allegation from inTEST that we were infringing on a patent held by inTEST. We have since then engaged in sporadic discussions with inTEST concerning this matter. On December 15, 2000, inTEST filed a complaint in the U.S. District Court for the District of Delaware against us, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001 we were served with the complaint. In addition to direct costs and diversion of resources which may result, we may be obligated to indemnify third parties for costs related to this allegation. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Securityholders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index on page 27 (b) Reports on Form 8-K 1) The Company filed a report on Form 8-K on May 17, 2001 announcing the execution of the definitive agreement for the registrant's acquisition of Integrated Measurement Systems, Inc. 2) The Company filed a report on Form 8-K on May 17, 2001 providing the definitive agreement for the registrant's acquisition of Integrated Measurement Systems, Inc. and a Shareholder Agreement by and among the Registrant, Iguana Acquisition Corporation, and Cadence Design Systems, Inc. 3) The Company filed a report on Form 8-K on June 4, 2001 providing an amendment dated June 1, 2001, to the Agreement and Plan of Merger and Reorganization, May 16, 2001, by and among the registrant, Iguana Acquisition Corporation and Integrated Measurement Systems, Inc. An amended and restated Shareholder Agreement, dated June 4, 2001, by and among the registrant, Iguana Acquisition Corporation and Cadence Design Systems, Inc. was also provided. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. 25 CREDENCE SYSTEMS CORPORATION -------------------------------- (Registrant) September 14, 2001 /S/ JOHN R. DETWILER ----------------------------- -------------------------------- Date John R. Detwiler John R. Detwiler, Senior Vice President, Chief Financial Officer and Secretary 26 EXHIBIT INDEX Exhibit Number ------ 2.15(1) Agreement and Plan of Merger and Reorganization, dated May 16, 2001, by and among Credence Systems Corporation, Iguana Acquisition Corporation and Integrated Systems, Inc. 2.16(2) Amendment No. 1 to Agreement and Plan of Merger and Reorganization, dated June 1, 2001, by and among Credence Systems Corporation, Iguana Acquisition Corporation and Integrated Measurement Systems, Inc. 4.7(3) Registration Rights Agreement, dated May 16, 2001, by and between Credence Systems Corporation and Cadence Design Systems, Inc. 10.36(2) Amended and Restated Shareholder Agreement effective as of May 16, 2001 and dated June 4, 2001, by and among Credence Systems Corporation, Iguana Acquisition Corporation and Cadence Design Systems, Inc. 10.37(3) Employment Agreement, dated March 30, 2001, by and between Credence Systems Corporation and John R. Detwiler. ___________________ (1) Incorporated by reference to an exhibit to the Company's Current Report on Form 8-K as filed with the Commission on May 17, 2001. (2) Incorporated by reference to an exhibit to the Company's Current Report on Form 8-K as filed with the Commission on June 4, 2001. (3) Incorporated by reference to an exhibit to the Company's Registration Statement on Form S-4 (Registration Statement No. 333-62386), as amended. 27