Item 1. Business
GENERAL
Integrated Measurement Systems, Inc. (the Company) was incorporated in Oregon in 1983. The Company operated as an independent entity until it was acquired by Valid Logic, Inc. ("Valid Logic") in 1989. In 1991, the Company became a wholly-owned subsidiary of Cadence Design Systems, Inc. ("Cadence") as a result of the merger of Valid Logic with Cadence. Both Cadence and Valid Logic operated the Company as a separate subsidiary. On July 21, 1995, the Company successfully completed an initial public offering of common stock, with 375,000 shares sold by the Company, and 2,615,000 shares sold by Cadence. In February 1997, the Company completed a secondary public offering of common stock, in which 700,000 shares were sold by the Company and 950,000 shares were sold by Cadence. As of December 31, 1999, Cadence owned approximately 36% of the outstanding shares of common stock of the Company. On September 3, 1998, the Company acquired all of the assets of PerformIC, a Germany-based designer and manufacturer of memory engineering Test Stations, and subsequently established its European Design Center in Dresden, Germany. The Company's European Design Center will concentrate on the development of technologies aimed at addressing the engineering test needs of memory manufacturers. The Company's common stock is traded on the NASDAQ National Market System under the symbol IMSC.
PRODUCTS AND SERVICES
The Company designs, manufactures, markets and services a family of versatile, high performance engineering IC validation systems. Customers use the Company's IC validation systems to test, at the prototype stage, complex digital, mixed-signal and memory devices such as microprocessors, application specific integrated circuits (ASICS's), multi-chip modules (MCM's), static random access memory (SRAM) and dynamic random access memory (DRAM) devices. In addition, the Company develops, markets and supports a line of Virtual Test Software that permits design and test engineers to automate test program development and to conduct simulated tests of electronic device designs prior to the fabrication of the prototype of the actual device. The Company's products enable its customers to shorten time-to-market, enhance accuracy of design, reduce both the time required to test and the cost of testing devices and provide reliable and prompt feedback to both design and test engineers.
IMS IC Validation Systems Products
The Company's IC validation systems play a variety of roles in bridging the gap between electronic design automation (EDA) to automated test equipment (ATE). At the beginning of the process, the Company's software converts design engineering data, including EDA simulation data, into data compatible with the Company's IC validation systems, thus bridging the gap between design software and verification. The IMS IC validation systems enable data conversion from popular simulation products including Verilog, VHDL, Quicksim and others.
The IMS IC validation systems stimulate the device under test by sending defined signals to the device, measuring the actual output and comparing it with the expected output. The IMS IC validation systems perform these functions at real-time device operating speeds. Using the Company's products, design and test engineers can identify failures, assess areas of concern, run short diagnostic sequences to pinpoint the cause(s) of failure, and identify changes needed to correct or enhance designs. IMS IC validation systems are designed to work with industry standard computers to receive and execute test commands and report the results of test procedures. IMS IC validation systems can also be linked to widely used EDA software tools, including those offered by Cadence, Mentor Graphics, Synopsys and others. The result is a reduction of the overall time required for verification and characterization, more timely feedback to design engineers and hence lower cost of design, reduced time-to-market and increased competitiveness for the companies designing today's increasingly complex integrated circuits.
The Company complies with industry standard conventions which facilitate compatibility with ATE equipment. Compatible output between the Company's IC validation systems and ATE systems enables rapid movement of devices from the engineering test environment to production test.
The Company's IC validation systems are designed and configured to match varying customer requirements. Generally, they differ from one another as to the maximum clock speed and data rates (from 40 MHz to 500 MHz), size of the device to be tested (from 16 to 896 or more total pins), device type (digital, mixed-signal, MCM, memory), flexibility in the number and variety of applications (verification, characterization, failure analysis, etc.), and price. IC validation systems typically range in price from $500,000 to $1.5 million, though high-speed, high-pin-count systems can sell for over $2.0 million (depending on configuration and intended application).
The Company currently offers three families of IC validation systems. The logic family, which accounted for 65% of total revenues in 1999, is the oldest and largest of the three families. Customers typically use the Company's logic IC validation systems to verify the designs of complex microprocessors, application specific IC's (ASIC's) and Multichip Modules (MCM's). Included in this family is the Vanguard, the Company's flagship product during 1999, which can test devices at up to 500MHz. The Vanguard systems sell for between $700,000 and $2,300,000, depending on the configuration, and accounted for the majority of logic family revenues in 1999. The logic IC validation system family also includes the ATS and XTS products, the Company's leading logic IC validation system products prior to 1999, which can test devices at up to 400MHz. These systems sell for between $250,000 and $1,800,000, depending on the configuration.
The mixed-signal family of IC validation systems includes the Electra and the Electra MX, which was introduced in 1999. Mixed-signal IC validation systems are used by customers to verify the designs of complex devices used in such applications as telecommunications, system-on-chip (SOC) and video electronics. Depending on the configuration, the mixed-signal IC validation systems can test devices at up to 400 MHz and sell for between $300,000 and $2,100,000. Mixed-signal Test Stations accounted for 10% of total revenues in 1999.
With the acquisition of Perform IC in September, 1998, the Company added its newest IC validation system family, the Orion Memory IC validation systems. The Orion is used by customers to verify the designs of complex SRAM's and DRAM's at speeds up to 200MHz. Depending on the configuration, these IC validation systems sell for between $350,000 and $500,000. The Company began shipping Orion IC validation systems to customers during the second quarter of 1999. Sales of the Orion Memory systems contributed 4% of total 1999 revenues.
IC Validation Systems Software Products
The Company has developed IC validation systems software products that are either embedded in the Company's IC validation systems or sold as separate add-on software products. These software packages provide optimal operation in various applications, including interactive device verification, automated device characterization, and EDA and ATE system linkages.
The Company's IC validation systems can be interfaced to a network, allowing the IC validation systems access to other resources on the network, and allowing multiple workstations on the network to have access to the IC validation system. Using various software tools available from the Company or from third-party vendors, users can import and export test data to and from the EDA environment. In addition, test information can be exported for use on traditional ATE systems.
Virtual Test Software
While EDA tools have helped improve designer productivity, little has been done to provide test development engineers with software productivity tools. As a result, test development times have increased while design time has been reduced. To address this trend, the Company has made a major commitment to providing a set of software tools for test engineers. These tools, called Virtual Test Software, allow the test engineer to accelerate the generation of a test program, simulate the test environment, develop the test fixture and document the entire test process. These tools are run on a workstation rather than on an expensive ATE system. This software can be used to simulate the ATE environment and eliminate the need to use ATE machines for debugging test programs, and
allows test engineers to develop test programs in parallel with the design, prototype manufacturing and engineering test processes.
The Company's TestDirect Virtual Test Software, introduced in 1997, is a productivity tool for digital test engineers. TestDirect is a test pattern generation program that provides test engineers with an automatic tool for generating ATE test patterns from the designer's original test bench simulation environment. This process shortens the test development time and the overall product development cycle, increasing a customer's revenue potential and improves their time-to-market competitiveness. The IMS Digital VirtualTester, introduced in 1998, is the first automated test productivity software tool to provide a high-quality, cost-effective way to verify and debug IC test patterns and timing on engineering workstations without having to wait until first silicon and without using valuable ATE time. Harnessing the power of EDA simulation and proprietary ATE data, the Digital VirtualTester can reduce time-to-market costs by allowing engineers to perform IC test development prior to silicon fabrication in a fault-free, virtual test environment.
Although the market for Virtual Test Software is difficult to quantify, the Company believes that its TestDirect, and Digital VirtualTester software products and services provide a significant advantage to semiconductor designers and test engineers . The Virtual Test software products currently operate in conjunction with Cadence, Synopsys and Mentor Graphics EDA software and certain ATE machines manufactured by Advantest, Agilent, Schlumberger, Teradyne and Credence later this year. In 1999, revenues from the sale of Virtual Test Software comprised approximately 5% of the Company's net sales.
RESEARCH AND DEVELOPMENT
The electronic design and test equipment market is subject to rapid technological change and new product introductions. The Company's ability to remain competitive in this market will depend in significant part upon its ability to continue to successfully develop and introduce new products and enhancements to existing products on a timely and cost-effective basis. There can be no assurance that the Company will be successful in developing and marketing new products and product enhancements that respond to technological change, evolving industry standards and changing customer requirements; that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products; or that its new products and product enhancements will adequately meet the requirements of the marketplace and achieve market acceptance.
The Company has historically devoted the great majority of its research and development efforts to the design and development of engineering IC validation systems and related hardware and software technologies. Certain of the Company's Virtual Test Software technologies were purchased by the Company. The Company is currently developing additional software products for its Virtual Test product line and expects to continue considerable internal research and development efforts for this product line in the future.
The Company also from time to time evaluates opportunities to acquire additional technology and assets. In 1998, the Company acquired PerformIC a developer of technologies aimed at addressing the engineering test needs of memory manufacturers. As a result, the Company has established its new European Design Center in Perform IC's facilities in Dresden, Germany to principally concentrate on developing IC validation system technologies to address the memory market.
The Company's research and development efforts are performed by approximately 82 employees at locations at Company headquarters in Beaverton, Oregon and the Company's European Design Center in Dresden, Germany.
MANUFACTURING OPERATIONS
The Company's test systems are complex and are used by the Company's customers in critical projects that demand a high level of quality and reliability. The Company invests significant resources to assure the high quality and reliability of its test systems and is committed to providing a high level of service to its customers in the event of
malfunction to minimize downtime. The Company's manufacturing operations primarily consist of order administration, materials planning, procurement, final assembly, quality control of materials, components and subassemblies, final systems integration and extensive calibration and testing. The Company uses manufacturing control software to monitor orders, purchasing, inventory, production and manufacturing costs.
The components used in the Company's products consist of standard parts available from numerous vendors, along with a number of proprietary items available only from sole or single source suppliers. The Company currently uses several independent third-party vendors to manufacture its subassemblies and semiconductor components, including circuit boards, integrated circuits and integrated circuit packaging, cable assembly and mechanical parts. External manufacturing is performed to the Company's specifications with technical support from the Company. In the event that any of the Company's third-party vendors, particularly its sole and single source vendors, were to experience financial, operational, production or quality assurance difficulties, or a catastrophic event that resulted in a reduction or interruption in supply to the Company, the Company's operating results could be materially adversely affected until the Company was able to establish sufficient manufacturing supply from alternative sources. While to date suitable third party manufacturing capacity has been available, there can be no assurance that such manufacturers will be able to meet the Company's future requirements or that such services will continue to be available to the Company at favorable prices.
The Company manufactures its digital and mixed-signal IC validation systems at its headquarters facility in Beaverton, Oregon. The Company's Orion IC validation systems are manufactured at its European Headquarters in Sargans, Switzerland.
The Company believes it has developed a strong vendor base, purchasing components and subassemblies both from national distributors and directly from vendors' factories. Some of the subassembly vendors are small, local companies to which IMS represents substantial volume.
Currently, the Company purchases a number of critical parts from sole source suppliers for which alternative sources are not available. The Company's reliance on a sole or a limited group of suppliers, some of which are small independent companies, and on outside subcontractors involves several risks, including a potential inability to obtain an adequate supply of required components and reduced control over pricing and timely delivery of components. The Company has generally been able to obtain adequate supplies of components in a timely manner from current vendors, or, when necessary to meet production needs, from alternate vendors. The Company has thus far been able to avoid any material adverse impact on timing of customer deliveries for its IC validation systems. However, no assurance can be given that supply problems will not occur or, if such problems do occur, that the Company's solutions to these problems will be effective in every case. Any prolonged inability to obtain adequate supplies of quality components or any other circumstances that would require the Company to seek alternative sources of supply could have a material adverse effect on the Company's business, financial condition and results of operations and could damage the Company's relationships with it customers.
The Company's IC validation systems have a history of staying in the market for many years. Over time suppliers of critical components may discontinue manufacturing such components. In such cases, when designing that component out of the product is deemed to not be feasible, the Company will place a last time buy order for the component. Although the Company uses the best information available at the time to determine the last time buy quantities, no assurance can be given that such quantities will be adequate to meet the requirements over the remainder of the product's remaining life. There also can be no assurance given that such life time buy quantities are not in excess of requirements over the product's remaining life.
MARKETING AND SALES
The Company markets its products in the United States through a direct sales force which has primary responsibility for developing orders, coordinating distribution, providing demonstrations and providing applications support. The Company employs skilled applications and service engineers and technically proficient sales people capable of serving
the sophisticated needs of prospective customers' engineering staffs as part of the customer support process. The U.S. sales force is managed from the Company's headquarters in Beaverton, Oregon and its regional offices in Irvine and Santa Clara, California; Boston, Massachusetts; Phoenix, Arizona; and Columbia, Maryland.
The Company markets its products in the European region through a direct sales force in France and the United Kingdom, and independent distributors in Germany, Scandinavia, Italy, Turkey and Israel Kingdom. In Asia the Company sells through through a direct sales force in Japan and through distributors in Taiwan, the People's Republic of China, Hong Kong, Malaysia/Singapore, Philippines and Korea. The Company's foreign sales and service operations are subject to risks inherent in foreign operations, including unexpected changes in regulatory requirements, exchange rates, tariffs or other barriers and potentially negative tax consequences. In addition, in certain jurisdictions, there is a risk of reduced protection for the Company's copyrights, trademarks and trade secrets. Additional information regarding foreign sales is contained in Notes 12 and 13 to the Financial Statements contained in this Annual Report.
The Company uses advertising in trade journals, technical articles, exhibits at trade shows, direct mail and telephone solicitations to build interest in the Company and its products. The Company provides extensive training for its sales representatives and distributors and supports its representatives and distributors with marketing tools, including sales brochures, demonstration test equipment and promotional product literature.
For the years ended December 31, 1999, 1998, and 1997, sales to one customer represented approximately 50%, 25% and 27% of the Company's net sales, respectively. No other customer accounted for more than 10% of the Company's net sales in 1999, 1998 or 1997.
COMPETITION
The design and test equipment market is highly competitive. Although the Company believes that it has a competitive advantage in the verification market due to the high performance and cost effectiveness of its products, the Company anticipates that technical advancement in the industry generally could lead to increased competition in the future.
The Company believes that the principal competitive factors in the verification and characterization markets are ease of use, product performance and reliability, price, marketing and distribution capability, service and support and the supplier's reputation and financial stability. The Company believes that it competes favorably with respect to all principal competitive factors and that it is particularly strong in the areas of ease of use, product performance, low cost and service and support.
The Company currently competes with a number of other verification and characterization equipment manufacturers. Competitors for the Company's digital and mixed-signal IC verification systems include companies such as Agilent, Teradyne, Credence and Schlumberger. The primary competitor for the Company's Orion memory IC validation systems is Mosaid. Most of these companies have significantly greater financial, marketing, manufacturing and technological resources than the Company. New product introductions or product announcements by the Company's competitors could cause a decline in sales or loss of market acceptance of the Company's existing products. Moreover, increased competitive pressure could lead to intensified price-based competition, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that its long-term success will depend largely on its ability to identify design and test needs ahead of its competitors and develop products which respond to those needs in a timely manner. In addition, no assurance can be given that other companies, including EDA companies, will not develop methodologies and products that are competitive with the Company's Virtual Test Software business. The Company also believes that to remain competitive, it will require significant financial resources in order to invest in new product development and to maintain a worldwide customer service and support network. There can be no assurance that the Company will continue to compete successfully in the future.
CUSTOMER SUPPORT AND SERVICE
To be competitive, the Company believes it must provide a high level of support and service. Support and service accounted for 16% of the Company's net sales for the fiscal year ended December 31, 1999. The Company maintains and supports products sold directly in the United States, Europe and Japan with the Company's service and support personnel. The Company's international distributors and dedicated international sales agents generally provide maintenance and support to their customers. The Company offers a toll-free technical support hotline to customers and distributors. Support engineers answer the technical support calls and generally provide same-day responses to questions that cannot be resolved during the initial call. When necessary, however, support engineers are dispatched to the customer's facility.
The Company maintains a rapid response program, which is designed to quickly respond to customer support issues. Many of the Company's customers currently have support agreements with the Company. The Company ranked first in 1998, 1997, 1996, 1995, 1994 and 1993 in customer satisfaction and quality for suppliers of test and material handling equipment according to VLSI Research, Inc. The Company generally warrants its IC validation systems for twelve months, and in certain instances for 24 months. During the warranty period, the Company will repair or replace failed components, will investigate all reported software problems and will endeavor to provide a solution. No assurances can be given that warranty costs will not increase in the future or that any such increase would not have a material adverse effect on the Company's financial condition and results of operations.
EMPLOYEES
At December 31, 1999, the Company had 268 employees, including 68 in marketing and sales, 83 in manufacturing and service, 82 in research, development and engineering and 35 in administration and finance. The Company also has 3 dedicated employees on the payroll of affiliated companies, which are international subsidiaries of Cadence. The Company reimburses Cadence the full cost of the employees' expense to Cadence under the terms of a Corporate Services Agreement between the Company and Cadence. These employees work full time on the Company's business and report to and are directly managed by the Company. See "Item 13. Certain Relationships and Related Transactions." The Company believes that its future success will depend on its continued ability to attract and retain highly qualified technical, management and marketing personnel. The Company's employees are not represented by a collective bargaining unit, and the Company believes that its employee relations are very good.
Item 2.
Item 2. Properties
The Company's executive offices, as well as its principal manufacturing, engineering and marketing operations, are located in a leased building of approximately 80,000 square feet in Beaverton, Oregon. The lease expires on February 29, 2004. The Company believes the space will be adequate through that period and, if required, suitable additional space is available nearby. The Company also leases a total of approximately 11,000 square feet of office space in which certain of its regional sales offices are located.
Item 3.
Item 3. Legal Proceedings
The Company is not a party to any material legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the security holders of the Company during the fourth quarter of the fiscal year ended December 31, 1999.
PART II
Item 5.
Item 5. Market for Registrants Common Equity and Related Stockholder Matters
The Company's common stock is traded publicly on the Nasdaq National Market under the symbol "IMSC." The following table sets forth, for the periods indicated, the high and low prices for the Company's common stock as reported by the Nasdaq National Market.
High Low ---- --- Fiscal 1998 First Quarter......................................... 17 3/8 11 Second Quarter........................................ 12 1/2 7 5/8 Third Quarter......................................... 10 5/8 5 3/8 Fourth Quarter........................................ 13 1/4 5 1/4 Fiscal 1999 First Quarter......................................... 11 7 Second Quarter........................................ 14 3/8 6 3/4 Third Quarter......................................... 15 1/16 9 3/4 Fourth Quarter........................................ 14 1/2 10 7/16
As of March 15, 2000, there were approximately 1,525 shareholders that held beneficial interests in shares of common stock. The Company has not paid any cash dividends on its common stock, and it does not anticipate paying any cash dividends in the foreseeable future.
During the quarter ended December 31, 1999, the Company made no sales of securities that were not registered under the Securities Act of 1933.
Item 6.
Item 6. Selected Financial Data
(In thousands, except per share amounts)
(a) Net income, basic earnings per share and diluted earnings per share for 1998, before nonrecurring acquisition and restructuring charges, were $129, $0.02 per share, and $0.02 per share, respectively.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
(Unless otherwise indicated, all numerical references are in thousands, except percentages and share data.)
The following discussion and analysis should be read in conjunction with Selected Financial Data and the Company's Consolidated Financial Statements and the Notes thereto included elsewhere in this Annual Report. This Annual Report, including the following discussion and analysis of financial condition and results of operations, contains certain statements, trend analysis and other information that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, which may involve risks and uncertainties. Such forward looking statements include, but are not limited to, statements including the words "anticipate," "believe," "plan," "estimate," "expect," "intend" and other similar expressions. The Company's actual results could differ materially from those discussed herein due to numerous factors including, but not limited to, those discussed in the following discussion and analysis of financial condition and results of operations, as well as those discussed elsewhere herein.
COMPANY BACKGROUND
The Company was founded in 1983 to design and develop engineering IC validation systems to test and measure complex electronic devices at the prototype stage. The Company was acquired by Valid Logic in 1989 and then by Cadence in 1991 as a result of the merger of Valid Logic into Cadence. Cadence operated the Company as a separate subsidiary.
In July 1995, the Company successfully completed an initial public offering of common stock, yielding net proceeds to the Company and Cadence of $3.3 million and $26.6 million, respectively. In February 1997, the Company completed a secondary public offering of its common stock, including 700,000 shares issued by the Company, and 950,000 shares sold by Cadence, yielding net proceeds to the Company and Cadence of $13.4 million and $18.6 million, respectively. As of December 31, 1999, Cadence continues to own approximately 36% of the Company's common stock.
RESULTS OF OPERATIONS
Net Sales
Net sales is comprised of engineering IC validation systems sales, software sales (including IC validation systems software and Virtual Test Software) and service sales, which consists primarily of revenue derived from maintenance and consulting contracts.
Net sales rose sharply in 1999 after two consecutive years of sales declines. In general, two factors contributed to the increase:
1) The product line is broader than it was two years ago. Towards the end of 1998, the Company released the 500Mhz Vanguard logic IC validation system, Electra and Electra MX mixed-signal IC validation systems, all of which contributed to the increase in net sales . Additionally, in mid-1999, the Company began customer shipments of the Orion Memory IC validation system . Systems and software sales for the last three years are as follows:
2) Capital spending within the Semiconductor Industry increased in 1999 for the first time in several years. Although our revenues do not necessarily correlate directly with industry capital spending, the increase in expenditures indicates a healthier selling environment for our products. Semiconductor capital spending over the past three years is as follows:
Systems Sales
Systems sales in 1999 increased $18.8 million or 84% over 1998, after decreasing $9.7 million or 30% in 1998 from 1997. Sales of the 500 MHz Vanguard logic IC validation system, almost entirely to the Company's largest customer, accounted for 46% of net system sales in 1999, up from 16% in 1998. The Vanguard is the Company's flagship product and eventually will be the platform for our mixed-signal and system-on-chip (SOC) solutions in addition to the current logic solutions. Sales of other logic systems declined by $1.2 million or 8% from 1998 as a result of the Vanguard ramp, but still accounted for 35% of net system sales. The Company expects these products to continue to contribute to revenues over the next several years. Mixed-signal systems sales increased $2.3 million or % over 1998, with most of the volume occurring in the latter part of 1999. Nearly all mixed-signal sales in 1999 were for the Electra family, while all mixed-signal sales in 1998 were for older generation products. The Company began shipping Orion memory IC validation systems in the second quarter of 1999. There were no revenues from memory systems in 1998.
System sales in 1998 declined $9.7 million or 30% from 1997. This decline resulted in part from the generally depressed state of the semiconductor industry, and in part because of a strategy shift made by the Company's largest customer. That customer was in the process of segmenting its markets over 1997 and 1998 and, as a result, spent substantially less money on the Company's systems as it developed and implemented its segmentation strategy. A number of the design starts resulting from this strategy shift are now getting to the prototype validation stage, driving the current demand for Vanguard systems.
Software Sales
System software sales increased $892 or 43% in 1999 from 1998. The increase is directly attributable to the increase in system sales, and particularly Vanguard system sales, which carry a higher dollar volume of software revenue. Virtual Test software revenues increased by $316 or 12% in 1999 from 1998, as increased sales of standardized Virtual Test software licenses more than offset reduced sales of custom software. The Company no longer pursues non-standard custom software sales, and now focuses on developing standard products that can be sold multiple times to multiple customers.
System software sales in 1998 increased $708 or 52% from 1997 largely due to the introduction of the Vanguard IC validation system in late 1998. Virtual Test software sales increased by $206 or 9% in 1998 compared to 1997, as the Company began shifting from non-standard custom software sales to standard software product sales as discussed above.
Service Sales
Service revenues declined in 1999 by $642 or 7% from 1998. In 1998, service revenues decreased $1.3 million or 12% from 1997. The principle reason for these declines was the Company's decision to exit the consulting business for Virtual Test and focus on sales of standard Virtual Test software products.
International sales amounted to 25% of net sales for the year ended December 31, 1999 compared to 26% and 34% of net sales for 1998 and 1997, respectively. The decrease in international sales since 1997 has been due primarily to much lower sales to customers in the Asia-Pacific region, partially offset by moderate improvement in net sales in Europe. Sales to one customer amounted to 50%, 25% and 27% of net sales in 1999, 1998, and 1997, respectively. No other customer accounted for more than 10% of the Company's net sales in 1999, 1998 or 1997.
Gross Margin
For the year ended December 31, 1999 gross margin was $34.9 million or 62% of net sales compared to $21.9 million or 65% of net sales, excluding non-recurring charges, for 1998, and $30.7 million or 66% of net sales for 1997. During 1999, slower growth for higher-margin software sales relative to growth in systems sales, increased provisions for warranty costs (due to an increase in standard warranty terms from 90 days to one year, and to two years for the Company's largest customer), and sales of certain lower-margin older generation systems resulted in gross margins below the prior years levels, excluding non-recurring charges. Overall gross margin percent in 2000 is expected to remain at similar levels to those realized in 1999.
The gross margin from sales of the Company's IC validation systems was 61% for 1999, compared to 64% for 1998, excluding non-recurring charges, and 62% for 1997. Software gross margin of 86% for 1999 was slightly higher than the 1998 gross margin of 85%. Software gross margin in 1998 and 1999 declined from 94% in 1997 due primarily to the impact of costs of customization of certain software products sold during the first half of 1998, and increased amortization of capitalized software development costs. Sales of services yielded gross margin of 50% for 1999, down from 58% in 1998 and 67% in 1997. Service gross margin declined from 1997 through 1999 due primarily to a decrease in higher-margin Virtual Test consulting contracts during these periods.
In September, 1998, the Company acquired all of the assets of PerformIC for a cash price of $1.3 million. PerformIC, located in Dresden, Germany, is a developer of technologies aimed at addressing the engineering test needs of memory manufacturers. In connection with this acquisition, a charge of $2.0 million was recorded in Systems Cost of Sales for inventories rendered obsolete by the PerformIC acquisition. With this acquisition, the Company opened its new European Design Center in Dresden.
Operating Expenses
For the year ended December 31, 1999, research, development and engineering (R&D) expenses increased by $1.6 million or 24% to $8.4 million from $6.8 million for the same period in 1998. R&D expenses were $7.4 million in 1997. The increase in 1999 was due primarily to the Company's investment in the development of the Orion memory IC validation system products, combined with lower capitalization of software development costs. As a percentage of net sales, R&D expenses were 15% for the year ended December 31, 1999 and 18% and 16% for 1998 and 1997, respectively. The decrease in R&D expenses as a percentage of net sales in 1999 was attributable to the increase in net sales discussed above. Capitalized software development costs and amortization were $1.9 million and $1.4 million, respectively, for the year ended December 31, 1999, compared with $2.4 million and $748, respectively, in 1998, and $1.1 million and $753, respectively, in 1997. Amortization of capitalized software
development costs increased in 1999 because capitalized amounts related to the Vanguard IC validation system and certain Virtual Test products began amortizing when the products were released to customers beginning in late 1998.
For the year ended December 31, 1999, selling, general and administrative (SG&A) expenses increased by $1.3 million or 8% to $19.1 million from $17.8 million in 1998. In 1998, SG&A expenses increased 10% or $1.6 million from $16.2 million in 1997. The increase in operating expenses in 1999 primarily reflects payment of sales commissions on higher sales volumes, and payment of employee performance bonuses attributable to Company achievement of specified operating income targets. The increase in SG&A expenses in 1998 over 1997 was principally the result of increased investment in the Company's direct distribution channels, most notably in Europe and Japan, as well as increased distributor commissions for sales in regions not served by the Company's direct sales organization. As a percentage of net sales, SG&A expenses decreased to 34% for the year ended December 31, 1999 compared to 48% for the same period in 1998 and 35% in 1997. The 1999 decrease in SG&A expenses as a percent of net sales resulted directly from the increase in net sales discussed above.
During the second half of 1998, the Company implemented a restructuring plan, including a reduction in the Company's worldwide employee headcount by approximately 14%, the termination of certain international distributor agreements, and the establishment of direct sales operations in Europe and Asia. The primary objectives of the restructuring plan were to strengthen the Company's international distribution channel, and to maintain acceptable operating expense levels as the Company moved forward.
The total non-recurring acquisition and restructuring charges recorded in 1998 operating expenses amounted to $1.9 million. These charges included acquired in-process research & development of $861 associated with the acquisition of PerformIC, $623 associated with the termination of certain international distributors, and $424 for severance costs.
Other Income, net
Other income, net was $834 for 1999, $760 for 1998 and $932 for 1997. The increase in other income, net for 1999 from 1998 was due primarily to foreign exchange transaction gains. The decrease in other income, net from 1997 to 1998 was due to the impact of lower average cash and investment balances on interest income.
Income Taxes
The Company's effective tax rate was 32% for the year ended December 31, 1999. The Company's benefit from income taxes for 1998 reflects recognition of a portion of the benefit from net operating loss carryforwards. At December 31, 1998, the Company had recorded deferred tax assets from net operating loss carryforwards of $3.5 million, against which it recorded a valuation allowance of $2.4 million. As the Company returned to profitability during 1999, this valuation allowance was reduced appropriately by approximately $2.1 million. Of this reduction in the valuation allowance, approximately $1.5 million was credited directly to Shareholders' Equity in recognition of the tax benefits from deduction of employee gains on stock option exercises for tax return purposes. The Company's effective tax rate for the year ended December 31, 1997 was 35%.
The Company's income tax position includes the effects of available tax benefits in certain countries where the Company does business, benefits for available net operating loss carryforwards, and tax expense for subsidiaries with pre-tax income. While management anticipates the Company's effective tax rate to remain at levels similar to 1999, this rate is very sensitive to the geographic and product mix of the Company's net sales, and therefore could be higher or lower in the future depending upon actual net sales realized.
Net Income
As a result of the various factors discussed above, net income for the year ended December 31, 1999 increased to $5.6 million or $0.70 per diluted share compared to a loss of $3.3 million or $0.44 per share for the corresponding period in 1998. Net income for the year ended December 31, 1997 was $5.2 million or $0.67 per diluted share.
Future Operating Results
Results of operations for the periods discussed above should not be considered indicative of the results to be expected in any future period, and fluctuations in operating results may also result in fluctuations in the market price of the Company's common stock. Like most high technology and high growth companies, the Company faces certain business risks that could have adverse effects on the Company's results of operations. These risks include, but are not limited to, the following:
Sales of the Company's products to a limited number of major customers are expected to continue to account for a high percentage of net sales over the foreseeable future. Any sudden reduction or loss of orders from any major customer would have a material adverse effect on the Company's financial condition and results of operations.
The Company is dependent on high-dollar customer orders, deriving a substantial portion of its net sales from the sale of engineering IC validation systems which typically range in price from $0.3 million to over $2.0 million per unit. A substantial amount of the Company's net sales are typically realized in the last few days of each quarter. During 1998, the Company's quarterly net sales were negatively impacted by customer decisions to delay or cancel plans to place orders for the Company's products in the last few days of the quarter. The timing and sales price of a single order can have a significant impact on the Company's net sales and results of operations for a particular period. The Company's net sales and results of operations may be negatively impacted if an order is received too late in a given period to permit product shipment during that period.
A significant portion of the Company's operating expenses is relatively fixed and planned expenditures are based, in part, on anticipated orders. In addition, the need for continued expenditures for research, development and engineering makes it difficult to reduce expenses in a particular quarter if the Company's sales goals for that quarter are not met. The inability to reduce the Company's expenses quickly enough to compensate for any revenue shortfall would magnify the adverse impact of any revenue shortfall on the Company's results of operations.
The Company purchases some key components from sole or single source vendors, for which alternative sources are not readily available. A few of these suppliers are small independent companies and could expose the Company to increased risk of temporary shortages for certain key components. The Company's future operating results and financial condition are also subject to influences driven by rapid technological changes, a highly competitive industry, a lengthy sales cycle, and the cyclical nature of general economic conditions.
Future operating results will depend on many factors, including demand for the Company's products, the introduction of new products by the Company and by its competitors, industry acceptance of Virtual Test software, the level and timing of available shippable orders and backlog, the duration and severity of the economic downturn in Asia, and the business risks discussed above. There can be no assurance that the Company's net sales will grow or that such growth will be sustained in future periods or that the Company will remain profitable in any future period.
Year 2000
During 1999 and 1998, the Company developed and executed its Year 2000 Readiness Plan which included steps to monitor, test and implement corrective measures for the Company's critical vendors and suppliers, products and information systems . The Company estimates the costs incurred during 1999 and 1998, including payments to third parties and estimates of internal costs, for developing and implementing its Year 2000 readiness plan were less than $300 and $200, respectively. To date, the Company has not been impacted by any material Year 2000 issues.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1999, the Company's principal sources of liquidity consisted of cash, cash equivalents and short-term investments of approximately $22.6 million, and funds available under an existing bank line of credit of $10.0 million. Since 1988, the Company has relied on cash generated from operations and cash raised through public stock offerings as its principal source of liquidity.
Operating Activities
The Company's net cash flows from operating activities includes cash received from customers, payments to suppliers, payments to employees and interest received and paid. During 1999 and 1997, net cash provided by operating activities amounted to $16.0 million and $8.8 million, respectively. During 1998, net cash used in operating activities amounted to $3.3 million.
For 1999, the Company realized a significant improvement in cash flow from operating activities, driven by the increase in net sales discussed above, combined with improvement in the days sales outstanding in trade receivables, and reductions in inventory levels. During 1998, a significant decline in revenues during a year where the Company continued to invest heavily in both its research and development efforts and in its distribution capabilities led to a decline in cash flow from operating activities. Other factors which negatively impacted cash flow from operating activities during 1998 were increases in trade receivables and inventories. The Company's trade receivables, inventories and accounts payable have fluctuated from period to period as a result of the timing of shipments, cash collections and inventory receipts near period end. The size and timing of a single customer shipment or collection can have a significant impact on trade receivables and inventories.
Trade receivables amounted to $14.0 million at December 31, 1999 and December 31, 1998. Because a more significant portion of the Company's quarterly net sales were realized earlier in each quarter during 1999 than the Company had experienced in 1998, days sales outstanding declined from 122 days at December 31, 1998 to 75 days at December 31, 1999. Inventories decreased from $14.9 million at December 31, 1998 to $13.2 million at December 31, 1999. This decrease was primarily due to the combination of increased sales volume and focused inventory reduction programs.
Investing Activities
Capital equipment expenditures of $3.1 million, $7.1 million, and $5.6 million in 1999, 1998, and 1997, respectively, were primarily for computers, software, demo equipment, engineering equipment and service spare parts used in the Company's operations. The higher level of capital spending during 1998 was largely driven by investments in production equipment and tooling necessary to begin shipments of the Company's Vanguard IC validation systems late in 1998. Following these significant investments, there was less need for additional capital expenditures during 1999.
In addition, the Company capitalized certain costs associated with software development of $1.9 million, $2.4 million and $1.1 million for 1999, 1998 and 1997, respectively. The higher amount in 1998 reflects the investment in software technology associated with the Company's new Vanguard IC validation systems which were introduced in late 1998.
Financing Activities
In 1999 and 1997, net cash provided by financing activities was $622 and $14.2 million, respectively. In 1998, net cash used in financing activities was $757.
In May 1998, the Company initiated a plan to repurchase up to 500,000 shares of its currently outstanding common stock over twelve months in open market and negotiated transactions. This repurchase program authorized the repurchase of shares in increments in accordance with SEC regulations and Board of Directors' guidance. During
1998, this program resulted in the repurchase of 150,500 shares at a total cost of $1.2 million. The Company did not repurchase any of its common stock during 1999.
Cash used for payments of certain capital leases obtained by the Company for computers and equipment used in operations was $395, $197 and $251 during 1999, 1998 and 1997, respectively. The Company received $1.0 million, $595, and $1.0 million in 1999, 1998 and 1997, respectively, from the issuance of stock under employee stock option and stock purchase plans. Cash provided by financing activities during 1997 was attributable to proceeds of $13.4 million from the Company's secondary public offering of common stock.
During 1999 and 1997, the Company realized reductions in current income tax liabilities of $1.7 million and $2.7 million, respectively, resulting from the benefit of tax deductions of employee gains upon exercise of Cadence stock options, and to a lesser extent from the exercise of the Company's employee stock options. During 1998, no such benefits were recorded as a result of the Company's pre-tax loss before deduction of such benefits. Had the Company generated sufficient pre-tax income during 1998, the tax benefits which would have been realized as a result of deduction of employee stock option gains would have amounted to approximately $1.5 million. For 1998, these deductions increased the Company's net operating loss carryforward for tax return purposes. During 1999, the Company generated sufficient pre-tax income to realize the benefit of the carryforward deduction of these option exercises. This benefit is included above in the realized reduction in income tax liabilities for 1999.
The compensation for tax purposes associated with stock option exercises and with disqualifying dispositions are typically not treated as expenses of the Company for financial reporting purposes, and the exercise of Cadence stock options does not increase the number of shares of Company common stock outstanding. The tax benefits available from the stock option deduction may decrease in the future as employee holdings of Cadence stock options decline due to option exercises and cancellations. The timing and magnitude of such decrease in tax benefits, if realized, is uncertain as the number of employee stock options which are exercised, and the amount of gains realized upon exercise, will be determined by, among other factors, fluctuations in the market value of Cadence common stock.
At the end of 1995, the Company secured a $10.0 million revolving line of credit with U.S. National Bank of Oregon, which is available for general corporate purposes as needed. Under the agreement, the Company can borrow, with interest at the bank's prime lending rate, or if lower, at certain margins above banker's acceptance or interbank offering rates. There have been no borrowings against the line of credit to date. The term of the current credit line agreement ends April 30, 2000. Management intends to renew the agreement at that time.
The Company believes that existing funds, funds expected to be generated by operating activities, and the available line of credit, will satisfy the Company's anticipated working capital and other general corporate purposes through at least the next twelve months. The Company currently has no significant capital commitments other than commitments under facility operating leases and vendor contracts for development services, consulting services and parts. From time to time, the Company may consider the acquisition of complementary businesses, products or technologies. The Company presently has no significant understandings, commitments or agreements with respect to any such acquisitions. Any such transactions, if consummated, may require additional financing. No assurance can be given that additional financing will be available or that, if available, such financing will be obtainable on terms favorable to the Company.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates relate primarily to its investment portfolio. The Company mitigates its risk by diversifying its investments among high credit quality securities in accordance with the Company's investment policy. As of December 31, 1999, the Company's investment portfolio includes marketable debt securities of $16.3 million. These securities are subject to interest rate risk, and will decline in value if the interest rates increase. Due to the short duration of the Company's investment portfolio, an immediate 10 percent increase in interest rates would not have a material effect on the Company's financial condition or the results of its operations.
Foreign Currency Exchange Rate Risk
The Euro is the functional currency of the Company's subsidiaries in France, Germany and Switzerland. The Yen is the functional currency of the Company's subsidiary in Japan. The Company does maintain cash balances denominated in currencies other than the U.S. Dollar in order to meet minimum operating requirements of its foreign subsidiaries.
The Company has limited involvement with derivative financial instruments and does not use them for trading purposes. Derivatives are used to manage well-defined foreign currency risks. The Company enters into forward exchange contracts to hedge the value of recorded short-term receivables and payables denominated in a foreign currency. Accordingly, the impact of exchange rates on the forward contracts will be substantially offset by the impact of such changes on the underlying transactions. The effect of an immediate 10 percent change in exchange rates on the forward exchange contracts and the underlying hedged positions denominated in foreign currencies would not be material to the Company's financial position or the results of its operations.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and schedule listed in Item 15(a)(1) and (2) are included in this Report beginning on Page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of Registrant
The information required by Item 401 of Regulation S-K is included under the captions "Election of Directors" and "Management" in the Company's Proxy Statement to be used in connection with the Company's 2000 annual meeting of shareholders to be held on or about May 16, and is incorporated herein by reference. The information required by Item 405 of Regulation S-K is included under the captions "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement to be used in connection with the Company's 2000 annual meeting of shareholders to be held on or about May 16, and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this item is included under the caption "Executive Compensation" in the Company's Proxy Statement to be used in connection with the Company's 2000 annual meeting of shareholders to be held on or about May 16, and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is included under the caption "Stock Owned by Management and Principal Shareholders" in the Company's Proxy Statement to be used in connection with the Company's 2000 annual meeting of shareholders to be held on or about May 16, and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is included under the caption "Certain Transactions and Relationships" in the Company's Proxy Statement to be used in connection with the Company's 2000 annual meeting of shareholders to be held on or about May 16, and is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Documents filed as part of this report:
(1) Financial Statements and Supplementary Data
The documents and schedule listed below are filed as part of this report on the pages indicated:
Page ---- Report of Independent Public Accountants Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Selected Quarterly Financial Data
(2) Financial Statement Schedules
The documents and schedule listed below are filed as part of this report on the pages indicated:
Page ---- Schedule II -- Valuation and Qualifying Accounts Report of Independent Public Accountants on Financial Statements Schedule
All other financial statement schedules have been omitted since they are not required, not applicable or the information is included in the consolidated financial statements or notes.
(3) Exhibits
Sequential Page Number
3.1. Restated Articles of Incorporation of Integrated Measurement Systems, Inc. Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
3.2. Second Restated Bylaws of Integrated Measurement Systems, Inc. Incorporated by reference to Exhibit 3(ii) of the Company's Report on Form 8-K filed March 26, 1998.
10.1. Form of Indemnity Agreement between Integrated Measurement Systems, Inc. and each of its executive officers and directors. Incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.2. 1995 Stock Incentive Plan. Incorporated by reference to Exhibit 10.2 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.3. 1995 Stock Option Plan for Nonemployee Directors. Incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.4. Form of Employment Agreement between Integrated Measurement Systems, Inc. and each of its executive officers. Incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.5. Asset Transfer Agreement between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 10.7 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.6. Tax Sharing Agreement between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 10.9 of the Company's Registration Statement on Form S-1 (Registration No. 33-92408)
10.7. Line of Credit agreement with US Bank. Incorporated by reference to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
10.8. Integrated Measurement Systems, Inc. 1995 Employee Stock Purchase Plan. Incorporated by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
10.9. Employment Agreement dated March 16, 1996 between Integrated Measurement Systems, Inc. and Keith L. Barnes. Incorporated by reference to
Exhibit 10.a of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996.
10.10. Amended Stockholder Agreement between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 10.15 of the Company's Registration Statement on Form S-1 (Registration No. 333-20495)
10.11. Amended Corporate Services Agreement between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 10.16 of the Company's Registration Statement on Form S-1 (Registration No. 333-20495)
10.12. Second Amendment to Joint Sales Agency Agreement between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 10.17 of the Company's Registration Statement on Form S-1 (Registration No. 333-20495)
10.13. Integrated Measurement Systems, Inc. Executive Deferred Compensation Plan. Incorporated by reference to Exhibit 10 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996.
10.14. Lease Agreement, dated September 22, 1997, between Integrated Measurement Systems, Inc. and Spieker Partners, LP, a limited partnership. Incorporated by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
10.15. Rights Agreement, dated as of March 25, 1998, between Integrated Measurement Systems, Inc. and ChaseMellon Shareholder Services, L.L.C. including the Articles of Amendment creating the Series A Participating Preferred Stock of Integrated Measurement Systems, Inc., the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B and C, respectively. Incorporated by reference to Exhibit 4.1 of the Company's Report on Form 8-K filed March 26, 1998.
10.16. Amended and Restated Shareholder Agreement, dated as of March 25, 1998, between Integrated Measurement Systems, Inc. and Cadence Design Systems, Inc. Incorporated by reference to Exhibit 4.2 of the Company's Report on Form 8-K filed March 26, 1998.
21. List of Subsidiaries of the Company*
23.1. Consent of Arthur Andersen LLP*
27.1. Financial Data Schedule*
--------
* File Herewith
(b) Reports on Form 8-K
No report on Form 8-K was filed during the quarter ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 30th day of March, 2000.
INTEGRATED MEASUREMENT SYSTEMS, INC.
By /s/ FRED HALL ---------------------------------
Fred Hall Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the 30th day of March, 2000.
Signature Title --------- -----
/s/ KEITH L. BARNES President, Chief Executive Officer, and Director - ----------------------- (Principal Executive Officer) Keith L. Barnes
/s/ FRED HALL Chief Financial Officer (Principal Financial - ----------------------- and Accounting Officer) Fred Hall
/s/ H. RAYMOND BINGHAM Chairman of the Board - ----------------------- H. Raymond Bingham
/s/ THOMAS R. FRANZ Director - ----------------------- Thomas R. Franz
/s/ PAUL GARY Director - ----------------------- Paul Gary
/s/ C. SCOTT GIBSON Director - ----------------------- C. Scott Gibson
/s/ MILTON R. SMITH Director - ----------------------- Milton R. Smith
/s/ JAMES E. SOLOMON Director - ----------------------- James E. Solomon
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF INTEGRATED MEASUREMENT SYSTEMS, INC.:
We have audited the accompanying consolidated balance sheets of Integrated Measurement Systems, Inc. (an Oregon corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Integrated Measurement Systems, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Portland, Oregon January 21, 2000
CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All numerical references are in thousands, except percentages and share data)
1. COMPANY BACKGROUND:
Integrated Measurement Systems, Inc. (the Company or IMS) commenced operations in August 1983. The Company was independent until acquired by Valid Logic in 1989. In 1991, Valid Logic merged with Cadence Design Systems, Inc. (Cadence) in a transaction accounted for as a pooling. From that time until July 21, 1995, the Company was a wholly owned subsidiary of Cadence.
In July 1995, the Company successfully completed an initial public offering of common stock. A total of 2,990,000 shares were sold, consisting of 375,000 shares issued by the Company and 2,615,000 shares sold by Cadence. In February 1997, the Company issued 700,000 additional shares of common stock, and Cadence sold 950,000 shares of the Company's common stock in a registered public stock offering. Net proceeds to the Company amounted to $13,400. At December 31, 1999, Cadence owned 36% of the outstanding common stock of the Company, with the remaining 64% publicly owned.
The Company is engaged in designing, developing, manufacturing, marketing and servicing high-performance engineering IC validation systems and software to test and measure the performance of complex electronic devices. In addition, the Company develops, markets and supports a line of Virtual Test Software that permits design and test engineers to automate test program development and to conduct simulated tests of electronic device designs prior to the fabrication of a prototype of the actual device.
The Company markets and supports its products worldwide through a network of direct sales force personnel, independent distributors and dedicated agents employed by Cadence in the United Kingdom.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the financial statements of Integrated Measurement Systems, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation.
Foreign Currency Translation
Assets and liabilities of foreign subsidiaries, where the functional currency is the local currency, are translated using exchange rates in effect at the end of the period and revenues and costs are translated using average exchange rates for the period. Gains and losses on translation into U.S. dollars of amounts denominated in foreign currencies for those operations where the functional currency is the local currency are not material. Transaction gains and losses are included in net income (loss) in the accompanying Consolidated Statements of Operations.
Use of Estimates
The preparation of financial statements in conformance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made in the accompanying financial statements for 1998 and 1997 to conform with the 1999 presentation.
Revenue Recognition
Revenue from systems sales and software licenses is generally recognized as the product ships and when no significant obligations remain. Contract service and support revenues billed in advance are recorded as deferred revenue and recognized ratably over the contractual period as the services and support are performed. Revenue from other services, such as consulting and training, is recognized as the related services are performed or when certain milestones are achieved.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles (GAAP) to revenue recognition in financial statements. The Company is required to adopt SAB 101 in the first quarter beginning after December 15, 1999. Although the Company believes its revenue recognition policies are in accordance with GAAP, the Company is currently studying SAB 101 and has not determined its impact on the Company's financial statements.
Cash and Cash Equivalents
The Company classifies all highly liquid investments with a maturity of three months or less at purchase as cash equivalents. The carrying amount approximates fair value because of the short maturity of these instruments. The Company's investments are placed with high credit-quality financial institutions and bear minimal credit risk.
Investments
The Company accounts for its investments in accordance with the Financial Accounting Standards Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). Under the provisions of SFAS 115, the Company is required to classify and account for its security investments as trading securities, securities available for sale or securities held to maturity depending on the Company's intent to hold or trade the securities at the time of purchase. The Company's short-term investments are placed with high credit-quality financial institutions or in short-duration, high quality debt securities. The Company limits the amount of credit exposure in any one institution or type of investment instrument. As of December 31, 1999, the Company's short-term investments consisted of debt securities issued by the Federal government and agencies of the United States, and high-quality corporate and financial institution obligations. Debt securities available for sale are carried on the balance sheet at fair market value, with the change in unrealized gain or loss included in Shareholders' Equity. The unrealized gain on the Company's investments in debt securities at December 31, 1999 and 1998 was not material .
Inventories
Inventories, consisting principally of computer hardware, electronic sub-assemblies and test equipment, are valued at the lower of cost (first-in, first-out) or market. Costs used for inventory valuation purposes include material, labor and manufacturing overhead.
December 31, 1999 1998 ------- -------
Raw materials ... $ 7,443 $ 9,265 Work-in-progress 2,184 2,608 Finished goods .. 3,549 3,070 ------- -------
Total inventories $13,176 $14,943 ======= =======
Property, Plant and Equipment
Property, plant and equipment is stated at cost and consists principally of equipment, furniture and leasehold improvements. Depreciation of equipment and furniture is computed principally on a straight-line basis over the estimated useful lives of the assets, generally three to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the lease, or the estimated useful lives of the improvements.
December 31, .................... 1999 1998 -------- --------
Leasehold improvements .......... $ 395 $ 324 Computer equipment and software . 6,185 6,521 Manufacturing and test equipment 4,918 5,081 Demonstration equipment ......... 12,697 10,661 Office furniture and equipment .. 1,167 840 -------- -------- 25,362 23,427 Less accumulated depreciation ... (14,625) (12,364) -------- -------- Net property, plant and equipment $ 10,737 $ 11,063 ======== ========
Service Spare Parts
Service spare parts consist of electronic components used to service IC validation systems for which the Company has entered into equipment maintenance agreements with customers. The Company classifies its service spare parts as non-current assets to reflect the long-term use of such parts in the Company's service business. These assets are not held for sale, diminish in value in a reasonably predictable manner, and therefore are subject to depreciation. Depreciation of the Company's service spare parts is computed on a straight-line basis over the estimated useful lives of the assets, generally eight years, and charged to Cost of Service Sales. Cost and accumulated depreciation of service spare parts are as follows:
December 31, ................ 1999 1998 ------- -------
Service spare parts, at cost $ 5,736 $ 5,905 Less accumulated depreciation (2,750) (2,213) ------- ------- Net service spare parts ..... $ 2,986 $ 3,692 ======= =======
Research, Development and Engineering Costs
Research, development and engineering costs are expensed as incurred.
Software Development Costs
The Company capitalizes certain software development costs incurred once technological and economic feasibility of the product has been demonstrated. These capitalized costs are amortized over the estimated economic life of the related product, generally three years, computed principally on a straight-line basis. Amortization is included in Cost of Systems Sales in the accompanying Consolidated Statements of Operations. The Company capitalized software development costs amounting to $1,873, $2,442 and $1,070 in 1999, 1998 and 1997, respectively. Related amortization expense of $1,415, $748 and $753 was recorded in 1999, 1998 and 1997, respectively.
December 31, ................. 1999 1998 -------- -------- Software development costs ... $ 10,616 $ 8,743 Less accumulated amortization (6,701) (5,286) -------- -------- Net software development costs $ 3,915 $ 3,457 ======== ========
Income Taxes
The Company accounts for income taxes under the asset and liability method as defined by the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". Under this method, deferred income taxes are recognized for the future tax consequences attributable to temporary differences between the financial statement and tax balances of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Stock-Based Compensation Plans
The Company accounts for its stock-based plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). The Company has adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123).
Earnings Per Share
The Company calculates earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). Basic earnings (loss) per share are computed using the weighted average number of common shares actually outstanding during the period. Diluted earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents outstanding during the period, calculated using the treasury stock method as defined in SFAS 128. The Company's common stock equivalents consist of dilutive shares issuable upon the exercise of outstanding common stock options. There are no differences in net income (loss) used for basic and diluted earnings (loss) per share. Following is a summary of common stock options outstanding but not included in the computation of diluted earnings (loss) per share because their effect would have been anti-dilutive.
Year ended December 31, ............................ 1999 1998 1997 --------- --------- --------- Number of shares of anti-dilutive options 82,920 1,706,617 32,500 Weighted average exercise price per share $ 13.22 $ 7.35 $ 18.99
Comprehensive Income
In July 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." The statement is effective for the Company's fiscal year ending December 31, 1998. SFAS 130 sets
standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is the total of net income and all other non-owner changes in equity. The only non-owner changes in equity recorded by the Company have been unrealized holding gains/losses on short-term investment securities classified as available-for-sale under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," and foreign currency translation adjustment resulting from translation of subsidiary financial statements into US dollars from the functional currencies in which the subsidiary financial statements are maintained. These non-owner changes in equity were not material, and therefore are not reported separately in the accompanying consolidated financial statements. The accumulated unrealized gains/losses on short-term investments and foreign currency translation adjustment are included in Additional Paid-in Capital in the accompanying Consolidated Balance Sheets.
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133), which was subsequently amended by "Accounting for Derivative Instruments and Hedging Activities" (SFAS 137) in June 1999. SFAS 133 and SFAS 137 require 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 income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The change in the derivative's fair value related to the ineffective portion of a hedge, if any, will be immediately recognized in earnings. The Company expects to adopt this Standard for fiscal 2001. The effect of adopting this standard is not expected to have a material effect on the Company's financial position or its results of operations.
The Company enters into foreign currency forward contracts (forward contracts) to manage exposure related to certain foreign currency transactions. All outstanding forward contracts at the end of the period are marked-to-market, with unrealized gains and losses included in net income as a component of other income, net. The Company may, from time to time, adjust its foreign currency hedging positions by taking out additional contracts or by terminating or offsetting existing forward contracts. These adjustments typically result from changes in the underlying foreign currency exposures. Realized gains and losses on terminated forward contracts, or on contracts that are offset, are recognized in income in the period of contract termination or offset. At December 31, 1999, the Company had outstanding forward contracts with notional amounts totaling approximately $1,478. These contracts, which mature within 45 days of year-end, are hedges of certain foreign currency transaction exposures in the British pound sterling, Euro, and Japanese yen. The estimate fair value of the contracts was negligible.
3. ACQUISITION AND RESTRUCTURING:
On September 3, 1998, the Company acquired all of the assets of PerformIC for a cash price of $1,319. PerformIC, located in Dresden, Germany, is a developer of technologies aimed at addressing the engineering test needs of memory manufacturers. The transaction was accounted for as a purchase. In connection with the purchase price allocation, the Company allocated a portion of the purchase price to acquired in-process research and development. At that time, the development of these products had not reached technological feasibility and the technology was believed to have no alternative future use. In accordance with generally accepted accounting principals, a charge for in-process research and development of $861 has been reflected in the accompanying Consolidated Statements of Operations as part of acquisition and restructuring costs in 1998. In addition, royalties are payable on future revenues derived from the acquired technology for up to five years from the date of acquisition.
The nature of efforts required to develop the purchased in-process technology into commercially viable products principally relate to the completion of all planning, designing, prototyping, verification and testing activities that are necessary to establish that the products can be produced to meet its design specifications, including functions, features and technical performance requirements. During 1999, the Company invested approximately $1,600 in research and development efforts necessary to introduce a commercially feasible product to market.
Pro forma combined statement of operations data for the years ended December 31, 1998 and 1997 was not materially different from results presented in the accompanying Consolidated Statements of Operations.
During the second half of 1998, the Company implemented a restructuring plan, including a reduction in the Company's worldwide employee headcount by approximately 14%, the termination of certain international distributor agreements, and the establishment of direct sales operations in Europe and Asia. The restructuring charge of $3,088 consisted of payments in connection with the termination of distributors, costs to set up direct international operations as a result of the expiration of a support agreement with Cadence, employee severance, writedowns of inventory made obsolete by the acquisition of PerformIC, and associated legal and consulting costs. Charges affecting inventories of $2,041 have been classified in Systems Cost of Sales in the accompanying Consolidated Statements of Operations. The remainder of the restructuring expenses were recorded as acquisition and restructuring expense in operating expenses.
The following is an analysis of the restructuring charge recorded for the year ended December 31, 1998:
Inventory write-downs ............... $2,041 Employee severance .................. 424 Distributor termination costs & other 623 ------ Total ............................... $3,088 ======
Substantially all of the restructuring costs were paid in 1998 and early 1999.
4. CAPITAL LEASE OBLIGATIONS:
The Company leases certain equipment under capital lease agreements, which are secured by the related assets. A schedule of future minimum lease payments under capital lease agreements as of December 31, 1999 is as follows:
2000 ................................ $ 172 2001 ................................ 222 -----
Total minimum payments .............. 394 Amount representing interest ........ (32) -----
Present value of future minimum lease payments .......................... 362 Less current portion ................ (149) -----
Long-term capital lease obligation .. $ 213 =====
5. COMMITMENTS:
The Company leases its facilities and certain equipment under operating leases that expire from 2000 to 2004. The approximate future minimum lease payments under these operating leases at December 31, 1999 are as follows:
2000 ................... $1,488 2001 ................... 1,392 2002 ................... 1,357 2003 ................... 1,293 2004 ................... 216 Thereafter ............. --
Rent expense was approximately $1,201, $1,385 and $1,164 for the years ended December 31, 1999, 1998 and 1997, respectively.
6. LINE OF CREDIT:
In December 1995, the Company secured a revolving line of credit with a bank allowing maximum borrowings of $10,000. The Company can borrow, with interest at the bank's prime lending rate, or if lower, at certain margins above bankers' acceptance on inter-bank offering rates. There have been no borrowings against the line of credit to date. Certain financial covenants are included in this agreement, which the Company was in compliance with at December 31, 1999. The line of credit is renewable April 30, 2000.
7. EMPLOYEE SAVINGS PLANS:
The Company has a profit sharing plan and trust that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the terms of the plan, the employees of the Company may make voluntary contributions to the plan as a percentage of compensation, but not in excess of the maximum allowed under the Code. Employees become eligible to participate in the plan on the first day of the calendar quarter following date of hire. The Company has not matched employee contributions. Effective in 2000, the Company plans to contribute to the plan an amount equal to 3% of each eligible employee's base compensation, subject to the Company's achievement of targeted operating income levels.
On July 1, 1996, the Company implemented an Executive Deferred Compensation Plan (the "Plan") for the purpose of providing eligible employees with a program for deferring compensation earned during employment. The Plan is intended to constitute an unfunded deferred compensation arrangement for the benefit of certain highly compensated employees of the Company. Under the terms of the Plan, eligible employees of the Company may make voluntary contributions to the Plan as a percentage of compensation, but not in excess of limitations stated in the Plan. The Company has invested these voluntary contributions in a variety of investment funds for the intended use of paying plan benefits when participating employees become eligible to receive such benefits under the terms of the Plan. These investments have been included in Prepaid expenses and other current assets in the accompanying Consolidated Balance Sheets. The Company currently does not match employee contributions and does not intend to do so in the near future.
8. EMPLOYEE AND DIRECTOR STOCK PLANS:
In May, 1995, the Company adopted the 1995 Stock Incentive Plan (the 1995 Plan) pursuant to which 2,215,000 shares of the Company's common stock have been reserved for issuance. Options under the 1995 Plan generally vest ratably over a four-year period from the date of grant, expire ten years from the date of grant, and are exercisable at prices generally not less than the fair market value at the grant date. During 1998 and 1997, the Company cancelled and reissued, with modified vesting provisions, certain incentive stock options granted to employees. The reissued options were granted at fair market value on the date of reissuance and have been reflected in the table below as cancellations and new grants. These options generally vest ratably over four years from the date of the reissuance. No option grants were cancelled and reissued during 1999.
In May, 1995, the Board of Directors approved the adoption of the 1995 Stock Option Plan for Nonemployee Directors (the "Nonemployee Director Plan") pursuant to which 250,000 shares of the Company's common stock have been reserved for issuance. The Nonemployee Director Plan covers directors who are not employees of the Company. The Nonemployee Director Plan allows for the automatic grant of 10,000 options upon becoming a director and 3,000 options annually thereafter. To-date, grants have been made at fair market value on the date of grant. These options vest ratably over three years from the date of grant. Since consummation of the Company's initial public offering, 75,000 stock options were awarded under the Nonemployee Director Plan. No stock options were awarded under the Nonemployee Director Plan during 1998 or 1999.
In May, 1996, the shareholders approved the adoption of the 1995 Employee Stock Purchase Plan (the "ESPP") pursuant to which 250,000 shares of the Company's common stock have been reserved for issuance to participating employees, of which 176,724 shares have been issued as of December 31, 1999. Eligible employees may elect to contribute up to 10 percent of their cash compensation during each pay period. The ESPP provides for two semiannual offering periods, beginning February 1 and August 1 of each year. During the offering periods, participants accumulate funds in an account via payroll deduction. At the end of each six-month offering period, the purchase price is determined and the accumulated funds are used to automatically purchase shares of the Company's common stock. The purchase price per share is equal to 85 percent of the lower of the fair market value of the common stock (a) on the Enrollment Date of the offering period or (b) on the date of the purchase. Effective February 1, 2000, the Company amended the ESPP to extend the offering period from six months to twenty-four months. Participants shall continue to accumulate funds into accounts via payroll deduction. At the end of the offering period the accumulated funds shall be used to automatically purchase shares of the Company's common stock. The purchase price per share shall continue to be equal to 85 percent of the lower of the fair market value of the common stock on (a) each participant's Enrollment Date or (b) the date of the purchase.
During 1995, the Financial Accounting Standards Board issued SFAS 123 which defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the method of accounting prescribed in APB 25. Entities electing to remain with the accounting in APB 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value based method of accounting defined in SFAS 123 had been applied.
The Company has elected to account for its stock-based compensation plans under APB 25. However, the Company has computed, for pro forma disclosure purposes, the value of all options granted and shares issued pursuant to the ESPP during 1999, 1998 and 1997 using the Black-Scholes option-pricing model as prescribed by SFAS 123, using the following weighted average assumptions:
Year ended December 31, 1999 1998 1997 ---- ---- ---- Risk-free interest rate ............. 5.5% 5% 6% Expected dividend yield ............. 0% 0% 0% Expected life ......... ............. 4 years 4 years 4 years Expected volatility ... ............. 77% 77% 56%
The total value of options granted during 1999, 1998 and 1997 would be amortized on a pro forma basis over the vesting period of the options. Options generally vest equally over four years. If the Company had accounted for these plans in accordance with SFAS 123, the Company's net income (loss) and net income (loss) per share would have changed as reflected in the following pro forma amounts:
Year ended December 31, 1999 1998 1997 --------- --------- --------- Net income (loss): As reported ......................... $ 5,581 $ (3,331) $ 5,205 Pro forma ........................... $ 3,411 $ (5,588) $ 3,463 Basic earnings (loss) per share: As reported ......................... $ 0.74 $ (0.44) $ 0.70 Pro forma ........................... $ 0.46 $ (0.75) $ 0.47 Diluted earnings (loss) per share: As reported ......................... $ 0.70 $ (0.44) $ 0.67 Pro forma ........................... $ 0.43 $ (0.75) $ 0.46
Options are generally issued with an exercise price equal to the price of the closing trade on the Nasdaq National Market on the date of issuance.
A summary of the status of the Company's stock option plans and changes are presented in the following table:
The following table sets forth the exercise price range, number of shares outstanding at December 31, 1999, weighted average remaining contractual life, weighted average exercise price, number of exercisable shares and weighted average exercise price of exercisable options by groups of similar price and grant date:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------- ---------------------- Weighted Average Weighted Weighted Exercise Outstanding Remaining Average Average Price Shares Contractual Exercise Exercisable Exercise Range at 12/31/99 Life (Years) Price Options Price - ------------- ----------- ------------ -------- ----------- --------
$ 5.75-$ 6.25 291,519 8.69 $ 6.20 101,157 $ 6.21 $ 7.00-$ 7.00 958,707 8.52 $ 7.00 491,859 $ 7.00 $ 7.25-$ 9.00 364,742 8.21 $ 8.68 136,355 $ 8.68 $ 9.13-$19.00 253,955 8.58 $11.16 92,250 $11.92
As of December 31, 1999, employees of the Company also held approximately 84,728 Cadence stock options, under the original terms of their issuance. These options were granted to IMS employees by Cadence prior to 1995 (see Note 1). Upon exercise of Cadence options, proceeds equal to the option exercise price pass to Cadence, and there is no impact on the number of shares of Company stock outstanding.
9. SHAREHOLDER RIGHTS PLAN:
In March 1998, the Company adopted a Shareholder Rights Plan (the "Rights Plan"). Under the Rights Plan, a dividend of one Share Purchase Right (a "Right") was declared for each share of Company Common Stock outstanding at the close of business on April 17, 1998. In the event that a person or group acquires 20% or more of the Company's Common Stock (other than stockholders currently owning 20% or more of Company Common Stock) without advance approval by the Board of Directors, each Right will entitle the holder, other than the acquirer, to buy Common Stock with a market value of twice the Right's then current exercise price (initially $70.00, subject to adjustment). In addition, if the new Rights are triggered by such a non-approved acquisition and the Company is thereafter acquired in a merger or other transaction in which the shareholders of the Company are not treated equally, shareholders with unexercised Rights will be entitled to purchase common stock of the acquirer with a value of twice the exercise price of the Rights.
10. INCOME TAXES:
The provision (benefit) for income taxes consisted of the following components:
Year ended December 31, 1999 1998 1997 ------- ------- -------
Current: Federal ............... $ 2,161 $ -- $ 2,052 State ................. 15 10 629
Foreign ............... 51 12 -- ------- ------- ------- 2,227 22 2,681
Deferred ................ 400 (518) 119 ------- ------- -------
Total ................. $ 2,627 $ (496) $ 2,800 ======= ======= =======
The effective tax rate differs from the Federal Statutory Tax Rate as follows:
Year ended December 31, 1999 1998 1997 ---- ---- ----
Federal statutory tax rate ................. 34.0% 34.0% 34.0% State taxes, net of Federal tax effect ............................... 1.1 (1.7) 4.4 Foreign tax rates .......................... 0.2 (2.2) -- Research and development tax credits ....... (2.2) 7.8 (3.1) Valuation allowance for deferred tax assets ........................... (4.6) (24.1) -- Other, net ................................. 3.5 (0.8) (0.3) ---- ---- ----
Total ................................ 32.0% 13.0% 35.0% ==== ==== ====
Net deferred tax assets consist of the following tax effects relating to temporary differences:
December 31, 1999 1998 ------- -------
Deferred tax assets: Inventory valuation .......................... $ 912 $ 844 Accrued vacation and other compensation ...... 524 654 Book in excess of tax depreciation ........... 148 130 Allowance for doubtful accounts .............. 148 150 Accrued warranty ............................. 396 108 Tax credit carryforwards ..................... 640 298 Net operating loss carryforwards ............. 823 3,538 Other ........................................ -- 33 ------- ------- Gross deferred tax assets .................... 3,591 5,755 Less valuation allowance ..................... (322) (2,388) ------- ------- 3,269 3,367 ------- -------
Deferred tax liabilities: Service spare parts valuation ................ (640) (440) Software development costs ................... (1,357) (1,255) ------- ------- (1,997) (1,695) ------- -------
Net deferred tax assets ...................... $ 1,272 $ 1,672 ======= =======
As of December 31, 1999, the Company had net operating loss carryforwards for income tax purposes of approximately $1,994. Such carryforwards will expire from 2003 to 2018 if not used by the Company to reduce income taxes payable in future periods.
As of December 31, 1999, the Company had research & development credit and alternative minimum tax credit carryforwards for income tax purposes of approximately $640. Such carryforwards will expire from 2018 to 2019 if not used by the Company to reduce income taxes payable in future periods.
For the years ended December 31, 1999 and 1997, income taxes payable have been reduced by $1,680 and $2,652, respectively, for the tax benefit from tax deduction of employee gains upon exercise of Cadence and IMS stock options. The tax benefit of the stock option deduction for 1999 and 1997 is reflected as an increase in Additional Paid-in Capital in the accompanying Consolidated Statements of Shareholders' Equity. The employee gains are generally not expenses of the Company for financial reporting purposes, and the exercise of Cadence stock options does not increase the number of shares of Company common stock outstanding.
11. TRANSACTIONS WITH CADENCE:
In certain foreign markets, Cadence employees act as sales agents for the Company. The Company reimburses Cadence for related costs incurred on the Company's behalf, plus an administrative fee. Cadence provides selling, service and production support related to the Company's Virtual Test Software. The Company has paid Cadence based upon estimated costs to provide this support, and related expenses have been reflected in the accompanying Consolidated Statements of Operations. Cadence provides facilities for certain domestic Company sales personnel. Charges for utilization of these facilities have been reflected in the accompanying Consolidated Statements of Operations as Selling, General and Administrative expense. For the years 1999, 1998 and 1997, the costs of the above services provided by Cadence totaled $657, $1,746 and $2,648, respectively. In 1997 the Company sold a mixed-signal IC validation system and related upgrades and peripherals to Cadence for $1,329, to be used by Cadence's design services group providing engineering test services to their customers. In 1998, the Company sold Virtual Test Software to Cadence for resale to Cadence customers in the amount of $1,176.
12. SEGMENT DISCLOSURES:
The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, during the fourth quarter of 1997. SFAS No. 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also established standards for related disclosures about products and services, and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company's chief operating decision making group is the Executive Committee, which is comprised of the Chief Executive Officer, Chief Financial Officer and the lead executives of each of the Company's operating segments. The reported operating segments are managed separately because each operating segment represents a strategic business unit that offers different products and serves different markets. Certain internal operating groups have been aggregated in the Test Systems segment below, due to significant similarities in their products & services, production processes, markets & customers, and common distribution channels.
The Company's reportable operating segments include Systems and Virtual Test. The Systems segment designs, develops, manufactures, markets and services high-performance engineering IC validation systems and software to test and measure the performance of complex electronic devices. Virtual Test designs, develops, manufactures and
markets software tools to help test engineers to accelerate the generation of test programs, simulate the test environment, develop the test fixture and document the entire test process for complex electronic devices.
The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies except that the separate financial results for the Company's operating segments have been prepared using a management approach, which is consistent with the basis and manner in which Company management internally reports financial information for the purposes of assisting in making internal operating decisions. The Company evaluates performance based on standalone operating income for each operating segment. Revenues are attributed to geographic areas based on the location of the customer taking delivery of the related products or services.
(a) Systems operating loss includes effect of the adjustment to write-off certain inventories made obsolete as a result of the acquisition of PerformIC.
(b) Other consists of acquisition and restructuring expenses.
(c) Other consists of cash & cash equivalents, short-term investments, deferred income taxes, and prepaid expenses and other current assets.
Exports sales are made to the Company's customers throughout Asia-Pacific and Europe. Sales by customer geographic region were:
Year ended December 31, 1999 1998 1997 ------- ------- ------- United States ............ $41,871 $27,051 $30,772 Asia-Pacific ............. 7,671 3,899 10,990 Europe ................... 6,387 5,582 4,842 Other .................... 141 165 246 ------- ------- -------
Total .................. $56,070 $36,697 $46,850 ======= ======= =======
Long-lived assets by geographic region were:
At December 31, 1999 1998 ------- -------
United States .... $17,197 $18,251 Asia-Pacific ..... 561 839 Europe ........... 795 342 ------- -------
Total .......... $18,553 $19,432 ======= =======
13. CONCENTRATIONS OF CREDIT RISK AND GEOGRAPHIC INFORMATION:
The Company sells to customers located throughout the United States, Asia-Pacific and Europe. Credit evaluations of its customers' financial conditions are performed periodically, and the Company generally does not require collateral from its customers. The Company maintains reserves for potential credit losses and such losses have been both immaterial and within management's expectations.
In 1999, 1998, and 1997, one customer accounted for 50 percent, 25 percent and 27 percent of net sales, respectively. The Company is subject to credit risk through trade receivables, which is minimized due to the size and financial stability of the Company's customers. At December 31, 1999 trade receivables by geographic region were:
United States ...................... $ 9,091 Asia-Pacific ....................... 2,255 Europe ............................. 2,867 -------- 14,213
Less allowance for doubtful accounts (257) --------
Trade receivables, net ............. $ 13,956 ========
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (In thousands, except per share data)
* Operating loss, net income (loss), basic earnings (loss) per share, and diluted earnings (loss) per share, before nonrecurring acquisition and restructuring charges for the quarter ended September 30, 1998, were $(155), $39, $0.01 per share, and $0.01 per share, respectively.
Operating loss, net income (loss), basic earnings (loss) per share, and diluted earnings (loss) per share, before nonrecurring acquisition and restructuring charges for the quarter ended December 31, 1998, were $(17), $130, $0.02 per share, and $0.02 per share, respectively.
INTEGRATED MEASUREMENT SYSTEMS, INC.
VALUATION AND QUALIFYING ACCOUNTS (In Thousands)
Report of Independent Public Accountants on Financial Statement Schedule
To the Board of Directors and Shareholders of Integrated Measurement Systems, Inc.:
We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Integrated Measurement Systems, Inc. included in the 1999 Form 10-K annual report and have issued our report thereon dated January 21, 2000. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The Valuation and Qualifying accounts schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Portland, Oregon January 21, 2000