Selected Financial Data
(in thousands, except per share data)
Stock and Dividend Information:
Common Stock of Lam Research Corporation (Lam or the Company) is traded in the
over-the-counter market under the Nasdaq National Market symbol LRCX. The price
range per share is the highest and lowest bid prices as reported by the National
Association of Security Dealers, Inc.
As of June 30, 1997, the Company had 1,012 stockholders of record.
No cash dividends have been declared or are anticipated to be paid by the
Company as all available funds are intended to be employed in the development of
the business, and the Company's financing agreements restrict the payment of
dividends.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
With the exception of historical facts, the statements contained in this
discussion are forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended, and are subject to the Safe
Harbor provisions created by that statute. Such forward-looking statements
include, but are not limited to, statements that relate to the Company's future
revenue, royalty income, gross margins, levels of research and development and
operating expenses, management's plans and objectives for future operations of
the Company, the effects of the Company's merger with OnTrak Systems, Inc.
(OnTrak), and the sufficiency of financial resources to support future
operations and capital expenditures. Such statements are based on current
expectations that involve risks and uncertainties, including those discussed
below and under the heading Risk Factors, that could cause actual results to
differ materially from those expressed. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. The Company undertakes no obligation to publicly release the results of
any revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. This discussion should be read in conjunction with the
Consolidated Financial Statements and Notes presented thereto on pages 22 to 35
of this Annual Report for a full understanding of the Company's financial
position and results of operations.
Results of Operations
The following table sets forth, for the fiscal years indicated, certain income
and expense items as a percentage of total revenue:
Fiscal 1997 vs. 1996
Lam's revenue for fiscal year 1997 totaled $1,002.4 million, a 21% decrease
from the prior fiscal year total revenue of $1,276.9 million. Overall, revenue
was lower in fiscal 1997 due to the reduced demand for Lam's equipment based
upon its customers' reduced production capacity requirements in response to a
slowdown in the semiconductor market. Also, during fiscal 1997, Lam's product
mix began to shift with a higher percentage of revenues contributed by the
multi-chamber Alliance and Chemical Vapor Deposition (CVD) products and a lower
percentage of revenues derived from the more mature single-chamber Rainbow and
Transformer Coupled Plasma (TCP) etch systems. Regionally, revenue reflected a
higher percentage attributable to North America sales, with revenue from foreign
regions decreasing to 58% of revenue in fiscal 1997 from 64% in fiscal 1996. The
Japan region experienced the largest decline in revenue, a 50% decrease from the
prior year representing approximately 31% of the total decline in revenue. Total
spares and service revenue dollars remained virtually flat in fiscal 1997
compared to fiscal 1996. Service revenue represented approximately 5% of total
revenue in fiscal 1997 and fiscal 1996.
During fiscal 1997, Lam's revenue declined sequentially for three quarters,
then increased for the fourth quarter. Lam anticipates that quarterly revenues
for the first half of fiscal 1998 are likely to be relatively flat with revenue
for the fourth quarter of fiscal 1997. The Company believes that as the industry
returns to historical growth rates revenues may increase during the second half
of fiscal 1998.
Royalty income for fiscal 1997 decreased 44% to $12.7 million from $22.8
million in fiscal 1996. The reduction in royalty income was due primarily to the
lower royalty rate effective January 1, 1997 under the extended royalty
agreement with Tokyo Electron Limited (TEL). The agreement, originally set to
expire on December 31, 1996, was renegotiated to a reduced royalty rate of 1%
from 5%. Lam expects that royalty income for fiscal 1998 will be significantly
lower than fiscal 1997 as 1998 will be the first full fiscal year with royalty
income from TEL computed at the reduced rate.
Lam's gross margin percentage for fiscal 1997 was 31.2% compared to 48.1%
for fiscal 1996. As noted above, during fiscal 1997, Lam's product mix shifted
from the higher-margin Rainbow and TCP products to the newer, lower-margin
Alliance cluster etch and CVD products. Furthermore, as a result of this faster
than expected customer transition to the multi-chamber from the single-chamber
tools, and continuing revisions to the design and features of such multi-chamber
products, during the third quarter of fiscal 1997, Lam established additional
reserves for excess and obsolete manufacturing and spare parts inventories and
inventory-related commitments of approximately $42.0 million. Lam also re-
evaluated its warranty and installation reserves and determined that additional
provisions of approximately $15.0 million were required, primarily because the
Alliance cluster and CVD tools are more costly to install and fulfill warranty
obligations.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Additionally, the slowdown in the semiconductor industry brought about reduced
manufacturing volumes which in turn caused Lam to experience an increase in
fixed manufacturing costs as a percentage of revenue. Also contributing to the
decline in gross margin percent was an overall decline in the spare parts and
service margin caused by a shift whereby a lower percentage of revenue was
derived from higher-margin spares and a higher percentage of revenue was derived
from lower-margin service.
While Lam expects that gross margin percentages in the first half of fiscal
1998 will continue to be affected by the slowdown in the semiconductor industry
and Lam's related excess manufacturing capacity, the Company anticipates that
the gross margin percentages may start to increase in the second half of fiscal
1998.
Research and development (R&D) expenses decreased to $170.6 million in
fiscal 1997 from $173.0 million in fiscal 1996. As a percentage of revenue, R&D
expenses increased to 17.0% of revenue in fiscal 1997 compared with 13.6% in
fiscal 1996. During the first quarter of fiscal 1997, Lam implemented a
restructuring of its operations which eliminated the previously existing
business unit structure. As a result of the restructuring, R&D activities were
centralized and certain duplicate R&D functions were eliminated. Partially
offsetting the overall decrease in R&D spending during fiscal 1997 was an
approximate $3.0 million write-off of R&D-related fixed assets during the third
quarter of fiscal 1997. Lam believes that in order to remain competitive in the
semiconductor equipment industry it must continue to significantly invest in
R&D. Over the next five to ten years, Lam intends to invest a significant
percentage of R&D resources to create production ready systems that allow Lam's
customers to process 300 mm wafers efficiently and effectively. Lam continues to
invest in advanced etch applications, and flat panel display (FPD) technology,
to develop its CVD technology and to make enhancements to its Alliance and TCP
products.
Selling, general and administrative (S,G&A) expenses decreased $30.7
million in fiscal 1997 from $227.8 million in fiscal 1996. During fiscal 1996,
Lam added employees in all administrative areas to accommodate the increase in
sales volume. During fiscal 1997, in response to the slowdown in the
semiconductor market and the decrease in sales volume, Lam implemented a
restructuring of its operations which resulted in a reduction in workforce and
initiated programs which reduced expenses and capital spending. Partially
offsetting the overall reduction in S,G&A expenses were $6.6 million of bad debt
expense for at-risk receivables relating to SubMicron Technology PLC (SubMicron)
and an adjustment of approximately $3.0 million for the write-off of certain
customer evaluation systems.
During fiscal 1997, Lam restructured its operations by consolidating its
previous business unit structure into a more centralized functional
organization. As a result of the restructuring, and in response to market
conditions, Lam reduced its workforce by approximately 11% and recorded a charge
of $9.0 million related primarily to severance compensation and consolidation of
facilities. At June 30, 1997, $1.7 million remains in accrued liabilities
relating primarily to executive severance and lease payments on remaining unused
facilities. As of June 30, 1997, Lam has made $6.3 million of cash payments
relating to the restructuring. Lam anticipates that operating expenses for the
first half of fiscal 1998 will remain relatively flat when compared with the
second half of fiscal 1997.
Interest expense for Lam decreased by 35% in fiscal 1997 from fiscal 1996,
due primarily to the retirement of the subordinated convertible debentures in
the fourth quarter of fiscal 1996. Lam expects that interest expense will
increase in future periods due to the additional interest expense which Lam will
incur on the Convertible Subordinated Notes, which Lam offered in August 1997
(see Note U). Lam also expects that interest income will increase as a result of
the additional cash acquired from sale of the Convertible Subordinated Notes.
Lam recorded a tax benefit of 48.5% of its pre-tax loss related primarily
to the benefit from its operating loss carryback and R&D tax credits for fiscal
1997.
Lam experienced its first net loss in fiscal 1997 since fiscal 1990. In
summary, items that contributed to the net loss included lower revenues due to
the slowdown in the semiconductor industry and lower gross margins due to the
transition from the higher-margin, mature Rainbow and TCP products to the lower-
margin Alliance and CVD products. Additionally, adjustments relating to excess
and obsolete manufacturing and spare parts inventory, increased reserves for
installation and warranty, a charge for the restructuring of operations and bad
debt expenses during the year contributed to the net loss.
On August 5, 1997, the stockholders of Lam approved the issuance of common
stock under the Agreement and Plan of Merger (the Merger Agreement) between Lam
and OnTrak. Each share of OnTrak common stock, par value $0.0001 per share
(OnTrak Common Stock), was exchanged for 0.83 of a share of Lam common stock,
par value $0.001 per share (Lam Common Stock), and each option and right to
acquire one share of OnTrak Common Stock was exchanged for options and rights to
purchase 0.83 of a share of Lam Common Stock. The transaction will be accounted
for as a pooling of interests and is structured to qualify as a tax-free
reorganization.
Lam's merger with OnTrak (the Merger) will give Lam entrance into the
chemical mechanical planarization (CMP) market and accordingly Lam anticipates
an increase in revenue related to the sale of CMP products. At this time, Lam
cannot predict the impact that the Merger will have on future results of
operations or financial condition.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
FISCAL 1996 VS. 1995
Lam's revenue for fiscal year 1996 increased to $1,276.9 million, a 58%
increase from the $810.6 million of revenue in fiscal 1995. Lam's TCP products
experienced increased sales in all regions and accounted for approximately one
half of the overall increase in revenue. Also contributing to the overall
increase in revenue for fiscal 1996 were sales of Lam's Rainbow and Alliance
products, which when combined accounted for approximately one-third of the
increase in revenue. Alliance revenue was particularly strong in the latter half
of fiscal 1996, as customers took delivery of the Alliance product in larger
quantities. Most of the remainder of the increase in revenue resulted from
increased spares and service revenue, which occurred as a result of Lam's
increased installed machine base. Lam experienced increased revenue in all
geographic regions, with foreign sales increasing to 64% of overall revenue from
54% in fiscal 1995. The Asia Pacific region, excluding Japan, accounted for
slightly more than one half of the increase in revenue obtained from foreign
sources. Also, the United States, Japan and European regions continued to show
increases in revenue, accounting for, in approximately equal amounts, the
remainder of the increase.
Royalty income was $22.8 million in fiscal 1996, an 85% increase over
fiscal 1995, due to the increased sales of systems incorporating Lam technology
by TEL and Sumitomo Metals Industries, Ltd. (Sumitomo).
Gross margins were 48.1% for fiscal 1996 compared with 48.3% for fiscal
1995. The slight decrease in gross margins can be attributed to the product mix
as Lam sold a relatively higher percentage of the lower-margin TCP and Alliance
machines and a relatively lower percentage of the higher-margin Rainbow
machines.
R&D dollar spending increased 35% in fiscal 1996 over fiscal 1995 and as a
percentage of revenues decreased by 2.2% to 13.6% in fiscal 1996. R&D spending
increased as Lam continued to invest in the development of advanced etch
applications, CVD technologies, including the DSM 9800 and DSM 9900, continued
enhancements to the TCP and Alliance products, and continued development of
Lam's FPD technology. Although R&D expenditures increased due to additional
engineering and scientific headcount, R&D expenditures increased at a rate
slightly slower than revenue increased. During the quarter ended June 30, 1996,
Lam began occupancy in an additional engineering facility at Lam's Fremont
campus, which Lam is utilizing under an operating lease.
S,G&A expenses increased by 57% in fiscal 1996 over fiscal 1995 and
decreased slightly as a percentage of sales. During fiscal 1996, Lam added
employees in all customer support, sales and administration areas to accommodate
the increased sales volume. During fiscal 1996, Lam significantly expanded its
foreign facilities: Lam opened a manufacturing facility in Korea, expanded its
facilities in Japan and relocated and began the expansion of its Taiwan
facility.
Interest expense for Lam increased by 17% in fiscal 1996 over fiscal 1995,
due to additional yen bank borrowings by Lam's Japanese subsidiary, additional
interest expense related to an interest rate swap and the increased interest
expense associated with the additional capital leases for equipment and
leasehold improvements. Other income decreased due to a $10.4 million one-time
gain recorded in the fourth quarter of fiscal 1995 from the sale of all of the
stock held by Lam in Brooks Automation, Inc., a vendor to Lam.
The combined effective tax rate was 32.5% for fiscal 1996, an increase over
the prior year's 30%, due primarily to the expiration of federal R&D tax
credits.
LIQUIDITY AND CAPITAL RESOURCES
Despite a net loss of $33.6 million for fiscal 1997, operating activities
provided approximately $80.2 million in cash flows. Non-cash depreciation and
amortization accounted for $53.1 million of the net operating cash flow;
partially offsetting the cash flow from depreciation and amortization
adjustments was $24.4 million related to additional deferred tax assets recorded
as a result of reserves recorded in the third quarter of fiscal 1997 which are
not immediately deductible for income tax purposes. Working capital accounts
provided $85.1 million in cash flows due to decreases in inventory and accounts
receivable, increases in accrued liabilities, and was partially offset by
increases in prepaid expenses and other assets. During fiscal 1997, inventories
decreased due to the impact of Lam's company-wide inventory reduction program
and additional reserves recorded in the third quarter, such decreases were
offset by increases in inventory needed to increase worldwide spares
capabilities. Lam's asset management efforts and the decrease in revenues
contributed to the overall decrease in the accounts receivable balance. Prepaid
expenses and other assets increased $19.4 million due to the reclassification of
the net balance of some other receivables and increases in prepaid corporate and
consumption taxes at Lam's foreign subsidiaries. During fiscal 1997, an
additional $60.0 million of cash was provided from the sale of yen-denominated
Japanese receivables to a bank. At June 30, 1997, $39.9 million of the total
receivables sold under this agreement remained uncollected by the bank and
subject to recourse provisions. Lam enters into foreign-currency forward
contracts to minimize the impact of exchange rate fluctuations on the value of
yen-denominated assets and liabilities. The realized gains and losses on these
contracts are deferred and offset against realized and unrealized gains and
losses from the settlement of the related yen receivables. The realized losses
on yen-forward contracts at June 30, 1997 were offset by gains on the underlying
receivables.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Net cash used for investing activities during fiscal 1997 was $22.2
million. Net capital expenditures were $39.5 million, primarily for the
completion of leasehold improvements. Offsetting cash used for investing were
net sales of short-term investments of $29.0 million. Cash totaling $11.7
million was also used to purchase certain technology rights and other
investments classified as other assets on Lam's balance sheet.
Net cash flows provided by financing activities were $4.8 million.
Contributing to the cash from financing activities was $13.4 million relating to
common stock issuances, primarily for the employee stock purchase and option
plans and net cash borrowings of $10.0 million against the syndicated line of
credit. Offsetting the cash contributions were payments of capital lease
obligations of $18.6 million.
As of June 30, 1997, Lam had $164.2 million in cash, cash equivalents and
short-term investments compared with $130.5 million at June 30, 1996. Lam has a
total of $210.0 million available under a syndicated bank line of credit, which
is due to expire in December 1998. Borrowings under the line of credit bear
interest at the bank's prime rate or 0.7% to 0.9% over London Interbank Offered
Rate (LIBOR) and are subject to Lam's compliance with financial and other
covenants. Lam received amendments or waivers for certain of its financial
covenants in anticipation of the net loss reported for the three and nine month
periods ended March 31, 1997. Lam was in compliance with all of the covenants as
amended at June 30, 1997. At June 30, 1997, Lam had borrowings against the
syndicated bank line of credit of $35.0 million. Borrowings under the line of
credit are unsecured. During August 1997, Lam completed an offering of $310.0
million of Convertible Subordinated Notes (the Notes). The Notes bear interest
at five percent, mature on September 1, 2002 and are convertible into shares of
Lam Common Stock at $87.77 per share. Expenses associated with the offering of
approximately $9.0 million will be deferred and will be included in other
assets. Such expenses will be amortized to interest expense over the term of the
Notes.
In connection with the issuance of the Notes, the Company received consents
and waivers with respect to certain financial and other covenants contained in
agreements related to certain existing financial arrangements. In addition, as a
consequence of the Merger with OnTrak as well as issuance of the Notes, the
Company, on or prior to the end of the fiscal quarter ending September 30, 1997,
would be out of compliance with certain other financial covenants unless
appropriate amendments or waivers are completed prior to that time. The Company
is currently in discussions with lenders that are party to these agreements.
Based on these discussions, the Company believes that appropriate amendments
or waivers will be obtained prior to fiscal quarter end on terms no less
favorable to the Company than the existing terms. In the event any such waivers
are not obtained by fiscal quarter end, the Company could be required to
terminate the revolving credit facility, purchase certain of its leased
facilities, purchase the sold receivables and pay the certain of Japanese
term loans.
Lam's commitments consist primarily of debt obligations and operating and
capital lease commitments for its facilities and equipment. Based upon current
forecasts, Lam's cash, cash equivalents, short-term investments and available
lines of credit at June 30, 1997 as well as the proceeds from the Notes are
expected to be sufficient to support anticipated levels of operations and
capital expenditures through at least June 30, 1998.
RISK FACTORS
FLUCTUATIONS IN QUARTERLY REVENUES
The Company's quarterly revenues have fluctuated in the past and may
fluctuate in the future. The Company's revenues are dependent on many factors,
including but not limited to the economic conditions in the semiconductor
industry, customer capacity requirements, the size and timing of the receipt of
orders from customers, customer cancellations or delays of shipments, the
Company's ability to develop, introduce and market new and enhanced products on
a timely basis, the introduction of new products by its competitors, changes in
average selling prices and product mix, and exchange rate fluctuations, among
others. The Company's expense levels will be based, in part, on expectations of
future revenues. If revenue levels in a particular quarter do not meet
expectations, operating results could be adversely affected. The Company derives
its revenue primarily from the sale of a relatively small number of high-priced
systems. The Company's systems including OnTrak's systems can range in price
from approximately $150,000 to over $3 million per unit. The sale of fewer
systems than anticipated in any quarter may have a substantial negative impact
on the operating results for the quarter. The Company's results of operations
for a particular quarter could be adversely affected if anticipated orders are
not received in time to enable shipment during such quarter, if anticipated
shipments are delayed or canceled by one or more customers, or if shipments are
delayed due to procurement shortages or manufacturing difficulties. The slowdown
in the semiconductor industry and in the construction of new wafer fabrication
facilities has resulted in the Company experiencing a reduction in new orders as
well as rescheduled and canceled orders. There can be no assurance that this
slowdown will not continue. The Company generally realizes a higher margin on
sales of its mature etch products, such as Rainbow etch systems, and on revenue
from service and spare parts than on sales of Alliance, CVD, FPD and newly
released TCP products. Newer products usually have lower margins in the initial
phase of production. The impact of these and other factors on the
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Company's revenues and operating results in any future period is difficult for
the Company to forecast. There can be no assurance that these and other factors
will not materially adversely affect the Company's future business and financial
results.
VOLATILITY IN THE SEMICONDUCTOR EQUIPMENT INDUSTRY
The business of the Company depends on the capital equipment expenditures
of semiconductor manufacturers, which in turn depend on the current and
anticipated market demand for integrated circuits and products utilizing
integrated circuits. The semiconductor industry has been cyclical in nature and
historically has experienced periodic downturns. The semiconductor industry has
been experiencing a slowdown of product demand and volatility in product
pricing. This slowdown and volatility have caused the semiconductor industry to
reduce or delay purchases of semiconductor manufacturing equipment and
construction of new fabrication facilities. These conditions have adversely
affected and may continue to adversely affect the Company's aggregate bookings,
revenues and operating results, and no assurance can be given that the Company's
bookings, revenue and operating results will not be adversely affected by future
downturns in the semiconductor industry. Even during periods of reduced
revenues, in order to remain competitive, the Company will be required to
continue to invest in R&D and to maintain extensive ongoing worldwide customer
service and support capability, which could adversely affect its financial
results.
RISKS RELATED TO THE MERGER WITH ONTRAK
Integration of Operations
The realization of the benefits sought from the Merger between Lam and
OnTrak depends on the ability of the combined company to effectively utilize the
joint product development capabilities, sales and marketing capabilities,
administrative organizations and facilities of the two companies. There can be
no assurance that these benefits will be achieved or that the activities of Lam
and OnTrak will be integrated in a coordinated, timely and efficient manner. The
combination of the two organizations also will require the dedication of
management resources, which will detract such persons' attention from the day-
to-day business of the Company. There can be no assurance that the integration
will be completed without disrupting the Company's business. The inability of
Lam and OnTrak to effectively utilize resources and to achieve integration in a
timely and coordinated fashion could result in a material adverse effect on the
Company's financial condition, operating results and cash flows. There can be no
assurance that the Company will retain and successfully integrate its key
management, technical, sales and customer support personnel, or that it will
obtain any of the anticipated benefits of the Merger.
Substantial Expenses Resulting from the Merger
Lam estimates that costs associated with the Merger were approximately
$17.7 million. Such expenses include investment advisory fees, legal and
accounting fees, financial printing costs and other Merger-related costs.
Although Lam does not believe that the costs will exceed the aforementioned
amount, there can be no assurance that the Company's estimate is correct or that
unanticipated contingencies will not occur that will substantially increase the
costs of combining the operations of the two companies. In any event, costs
associated with the Merger will negatively impact results of operations in the
fiscal quarter ending September 30, 1997.
Potential Dilutive Effect to Stockholders
Although Lam believes that beneficial synergies will result from the
Merger, there can be no assurance that combining the two companies' businesses,
even in an efficient, effective and timely manner, will result in combined
results of operations and financial condition superior to what would have been
achieved by each company independently, or as to the period of time required to
achieve such result. The issuance of Lam Common Stock in connection with the
Merger may have the effect of reducing the Company's net income per share from
levels otherwise expected for Lam and could reduce the market price of Lam
Common Stock unless revenue growth or cost savings and other business synergies
sufficient to offset the effect of such issuance can be achieved.
DEPENDENCE ON NEW PRODUCTS AND PROCESSES; RAPID TECHNOLOGICAL CHANGE
Rapid technological changes in semiconductor manufacturing processes
subject the semiconductor manufacturing equipment industry to increased pressure
to maintain technological parity with deep submicron process technology. The
Company believes that the future success of the Company will depend in part upon
its ability to develop, manufacture and successfully introduce new products and
product lines with improved capabilities and to continue to enhance existing
products. Due to the risks inherent in transitioning to new products, the
Company will be required to accurately forecast demand for new products while
managing the transition from older products. If new products have reliability or
quality problems, reduced orders, higher manufacturing costs, delays in
acceptance of and payment for new products and additional service and warranty
expenses may result. In the past, the Company has experienced some delays as
well as reliability and quality problems in connection with product
introductions, resulting in some of these consequences. There can be no
assurance that the Company will successfully develop and manufacture new
products, or that new products introduced by the Company will be accepted in the
marketplace. If the Company does not successfully introduce new
Management's Discussion and Analysis
of Financial Condition and Results of Operations
products, the Company's results of operations will be materially adversely
affected.
In addition, the Company expects to continue to make significant
investments in R&D. The Company also must manage product transitions
successfully, as introduction of new products could adversely affect sales of
existing products. There can be no assurance that future technologies, processes
or product developments will not render the Company's current product offerings
obsolete or that the Company will be able to develop and introduce new products
or enhancements to existing products which satisfy customer needs in a timely
manner or achieve market acceptance. The failure to do so could adversely affect
the Company's business. Furthermore, if the Company is not successful in the
marketing and selling of advanced processes or equipment to customers with whom
the Company has formed strategic alliances, the results of operations of the
Company to sell its products to those customers could be adversely affected. In
addition, in connection with the development of the Company's new products, the
Company will invest in high levels of preproduction inventory, and the failure
to complete development and commercialization of these new products in a timely
manner could result in inventory obsolescence, which could have an adverse
effect on the Company's financial results.
PRODUCT CONCENTRATION; LACK OF PRODUCT REVENUE DIVERSIFICATION
A substantial percentage of the Company's revenues to date have been
derived from a limited number of products, and such products are expected to
continue to account for a substantial percentage of the Company's revenues in
the near term. Collective sales of the Company's two primary products, Alliance
multi-chamber etch cluster tools and TCP single-chamber etch systems, accounted
for approximately 66% of Lam and OnTrak's combined machine revenues for the
fiscal year ended June 30, 1997. Continued market acceptance of the Company's
primary products is therefore critical to the future success of the Company. Any
decline in demand for or failure to achieve continued market acceptance of such
products or any new version of these products, if any, as a result of
competition, technological change, failure of the Company to timely release new
versions of these products, or otherwise, could have a material adverse effect
on the business, operating results, financial condition and cash flows of the
Company. During the quarter ended March 31, 1997, the Company experienced a
faster than anticipated transition from its single-chamber etch products to its
next generation, multi-chamber etch cluster tools, which has resulted in the
need for higher-than-anticipated reserve provisions for excess and obsolete
manufacturing and spare parts inventories and additional provisions for
installation and warranty costs. These factors, among others, have resulted in
the Company reporting a loss for the fiscal year ended June 30, 1997.
DEPENDENCE UPON KEY SUPPLIERS AND KEY DISTRIBUTORS
Certain of the components and subassemblies included in the products of the
Company are obtained from a single supplier or a limited group of suppliers. The
Company's key suppliers include Bullen Ultrasonics, Inc., which supplies
electrodes, Edwards High Vacuum Inc., Lam's supplier of chillers, and Advanced
Energy Industries, Lam's RF generator supplier. Lam purchases in excess of
$500,000 of supplies on a monthly basis from these suppliers. Each of these
suppliers has a one year blanket purchase contract with Lam under which Lam may
issue purchase orders. These contracts may be renewed annually. Each of these
suppliers has sold products to Lam during at least the last four years, and Lam
has no reason to expect that they will not continue to renew these contracts in
the future. Lam believes that alternative sources could be obtained and
qualified to supply these products. Nevertheless, a prolonged inability to
obtain certain components could have an adverse effect on the Company's
operating results and could result in damage to customer relationships.
Highly Competitive Industry
The semiconductor processing industry is highly competitive. The Company
has experienced and expects to continue to face substantial competition
throughout the world. A substantial investment is required by semiconductor
manufacturers to install and integrate capital equipment into a semiconductor
production line. The Company believes that as a result, once a semiconductor
manufacturer has selected a particular supplier's capital equipment, the
manufacturer generally relies upon that equipment for the specific production
line application and frequently will attempt to consolidate its other capital
equipment requirements with the same supplier. Accordingly, the Company would
expect to experience difficulty in selling to a given customer if that customer
had initially selected or selects a competitor's capital equipment. The Company
believes that to remain competitive, the Company will require significant
financial resources in order to offer a broad range of products, to maintain
customer service and support centers worldwide, and to invest in product and
process R&D.
The Company intends to continue to invest substantial resources to increase
sales of its systems to Japanese semiconductor manufacturers, who represent a
substantial portion of the worldwide semiconductor market and whose market is
difficult for non-Japanese equipment companies to penetrate. The Company
believes that the semiconductor equipment industry is becoming increasingly
dominated by large manufacturers who have the resources to support customers on
a worldwide basis, and certain of its competitors have substantially greater
financial resources and more extensive engineering, manufacturing, marketing and
customer service and support capabilities than the Company. In addition, there
are smaller emerging semiconductor
equipment companies that provide innovative technology that may have performance
advantages over systems offered by the Company.
The Company faces significant competitive factors in the etch equipment
market which include etch quality, repeatability, process capability and
flexibility and overall cost of ownership, including reliability, software
automation, throughput, customer support and system price. Although the Company
believes that it competes favorably with respect to each of these factors, the
Company's ability to compete successfully in this market will depend upon its
ability to introduce product enhancements and new products on a timely basis.
There can be no assurance that the Company will continue to compete successfully
in the future. In the etch equipment market, the Company's primary competitors
are Applied Materials, Inc., TEL and Hitachi Ltd.
The Company faces significant competitive factors in the CVD equipment
market, including film quality, flow uniformity, contamination control,
temperature control and overall cost of ownership, including throughput, system
reliability, cost of consumables, system price and customer support. In the CVD
equipment market, the principal suppliers of equipment are Applied Materials,
Inc., Canon Sales Co. Inc., Novellus Systems, Inc. and Watkins-Johnson Company.
The CMP polishing system under development by the Company is expected to
face significant competition from multiple current and future competitors.
Companies currently offering polishing systems include Applied Materials, Inc.,
Cybeq Systems, Ebara Corporation, Integrated Process Equipment Corp. (IPEC),
SpeedFam Corp., Strasbaugh and Sumitomo. IPEC currently has the largest
installed base of CMP polishers and also offers an integrated CMP polishing and
cleaning system. Lam believes that other companies are developing polishing
systems and are planning to introduce new products to this market before or
during the same time frame as the Company's planned introduction of its CMP
polishing system.
In CMP slurry removal and cleaning applications, OnTrak's principal
competitor is Dainippon Screen Manufacturing Co. Ltd. (Dainippon Screen). OnTrak
expects that it will face increased competition from IPEC, which currently
offers a slurry removal cleaning system, and SpeedFam, as well as others as the
CMP market continues to develop. In general cleaning applications, OnTrak
competes against Dainippon Screen and others.
The Company expects its competitors to continue to improve the design and
performance of their current products and processes and to introduce new
products and processes with improved price and performance characteristics. If
the Company's competitors enter into strategic relationships with leading
semiconductor manufacturers covering etch, CMP or CVD products similar to those
sold or being developed by the Company, the Company's ability to sell its
products to those manufacturers could be adversely affected. No assurance can be
given that the Company will continue to compete successfully in the United
States or worldwide.
Present or future competitors may be able to develop products comparable or
superior to those offered by the Company or adapt more quickly to new
technologies or evolving customer requirements. In particular, while the Company
currently is developing additional product enhancements that it believes
addresses customer requirements, there can be no assurance that the development
or introduction of these additional product enhancements will be successfully
completed on a timely basis or that these product enhancements will achieve
market acceptance. Accordingly, there can be no assurance that the Company will
be able to continue to compete effectively in its markets, that competition will
not intensify or that future competition will not have a material adverse effect
on the business, operating results, financial condition and cash flows of the
Company.
INTERNATIONAL OPERATIONS AND EXPANSION
International sales accounted for 58%, 64%, and 54%, respectively, of the
Company's net revenues in the fiscal years 1997, 1996 and 1995. The Company
anticipates that international sales will continue to account for a significant
portion of net sales. Additionally, the Company intends to continue expansion of
international operations, including expansion of facilities in the Asia Pacific
region. As a result, a significant portion of the Company's sales and operations
will be subject to certain risks, including tariffs and other barriers,
difficulties in staffing and managing foreign subsidiary and branch operations,
difficulties in managing distributors, potentially adverse tax consequences and
the possibility of difficulties in accounts receivable collection.
In addition to the uncertainty as to the Company's ability to expand its
international presence, there are certain risks inherent in doing business on an
international level, such as unexpected changes in regulatory requirements,
political instability, fluctuations in currency exchange rates, and seasonal
reductions in business activity during summer months in Europe and certain other
parts of the world, any of which could have an adverse impact on the success of
international operations. Sales of products by the Company currently are
denominated principally in United States dollars. Accordingly, any increase in
the value of the United States dollar as compared to currencies in the Company's
principal overseas markets would increase the foreign currency-denominated cost
of the Company's products, which may negatively affect the Company's sales in
those markets. The Japanese yen has decreased in value relative to the United
States dollar in recent months. In addition to the potential impact on the
pricing of the Company's products, this decline will likely lower the rate
Management's Discussion and Analysis
of Financial Condition and Results of Operations
of dollar revenue growth. Currently, the Company enters into foreign currency
forward contracts to minimize the impact of exchange rate fluctuations on the
value of the yen-denominated assets and liabilities, and the Company will enter
into such hedging transactions in the future. In addition, effective patent,
copyright, trademark and trade secret protection may be limited or unavailable
under the laws of certain foreign jurisdictions. There can be no assurance that
one or more of such factors will not have a material adverse effect on the
Company's international operations and, consequently, on the business, operating
results, financial condition and cash flows of the Company. The Company's Korean
manufacturing facility may experience difficulties in management, procurement,
production and staffing. There can be no assurances that these factors will not
have an adverse effect on the Company's business, financial condition and
results of operations.
INTELLECTUAL PROPERTY MATTERS
From time to time, the Company has received notices from third parties
alleging infringement of such parties' patent rights by the Company's products.
In such cases, it is the policy of the Company to defend against the claims or
negotiate licenses on commercially reasonable terms where considered
appropriate. However, no assurance can be given that the Company will be able to
negotiate necessary licenses on commercially reasonable terms, or at all, or
that any litigation resulting from such claims would not have a material adverse
effect on the Company's business and financial results.
In October 1993, Varian Associates, Inc. (Varian) brought suit against the
Company in the United States District Court for the Northern District of
California, seeking monetary damages and injunctive relief based on the
Company's alleged infringement of certain patents held by Varian. The lawsuit is
in the late stages of discovery and has been reassigned to a new judge. The
trial date has been set for March 1998. The Company has asserted defenses of
invalidity and unenforceability of the patents that are the subject of the
lawsuit, as well as noninfringement of such patents by the Company's products.
While litigation is subject to inherent uncertainties and no assurance can be
given that Lam will prevail in such litigation or will obtain a license under
such patents on commercially reasonable terms, or at all, if such patents are
held valid and infringed by the Company's products, the Company believes that
the Varian lawsuit will not have a material adverse effect on the Company's
operating results or the Company's financial position.
The Company's success depends in part on its proprietary technology. While
the Company attempts to protect its proprietary technology through patents,
copyrights and trade secret protection, it believes that the success of the
Company will depend on more technological expertise, continuing the development
of new systems, market penetration and growth of its installed base and the
ability to provide comprehensive support and service to customers. There can be
no assurance that the Company will be able to protect its technology or that
competitors will not be able to develop similar technology independently. The
Company currently has a number of United States and foreign patents and patent
applications. There can be no assurance that any patents issued to the Company
will not be challenged, invalidated or circumvented or that the rights granted
thereunder will provide competitive advantages to the Company.
ENVIRONMENTAL REGULATIONS
The Company is subject to a variety of governmental regulations related to
the discharge or disposal of toxic, volatile, or otherwise hazardous chemicals
used in the manufacturing process. The Company believes that it is in general
compliance with these regulations and that it has obtained (or otherwise
addressed) all necessary environmental permits to conduct its business, which
permits generally relate to the disposal of hazardous wastes. Nevertheless, the
failure to comply with present or future regulations could result in fines being
imposed on the Company, suspension of production or cessation of operations.
Such regulations could require the Company to acquire significant equipment or
to incur substantial other expenses to comply with environmental regulations.
Any failure by the Company to control the use of, or adequately restrict the
discharge or disposal of, hazardous substances could subject the Company to
future liabilities.
DEPENDENCE ON KEY PERSONNEL AND DIFFICULTY OF IDENTIFYING AND HIRING CERTAIN
PERSONNEL
The performance of the Company is substantially dependent on the
performance of its executive officers and key employees. The loss of the
services of any of the executive officers or other key employees of Lam or
OnTrak could have a material adverse effect on the business, operating results,
financial condition and cash flows of the Company.
The future success of the Company also depends on its continuing ability to
identify, hire, train and retain other highly qualified technical and managerial
personnel. Competition for such personnel is intense, and the Company has
experienced difficulty in identifying and hiring qualified engineering
personnel. There can be no assurance that the Company will be able to attract,
assimilate or retain highly qualified technical and managerial personnel in the
future. The inability to attract and retain the necessary technical and
managerial personnel could have a material adverse effect on the Company's
business, operating results, financial condition and cash flows.
MANAGEMENT TRANSITION
In recent years, the Company has experienced expansion of its operations
that has placed significant
Management's Discussion and Analysis
of Financial Condition and Results of Operations
demands on its respective administrative, operational and financial resources,
the demands of which are expected to intensify as a result of the Merger. James
W. Bagley, the Chairman and Chief Executive Officer of OnTrak, became the Chief
Executive Officer of Lam on August 6, 1997. In addition, Lam hired a new Chief
Financial Officer, Mercedes Johnson, in April 1997 and a new Chief Operating
Officer, Stephen G. Newberry, in August 1997. There can be no assurance that
such management transitions can be accomplished in an efficient manner without
business disruption.
MANAGEMENT OF POTENTIAL GROWTH; INTEGRATION OF POTENTIAL ACQUISITIONS
To manage future growth, if any, management of the Company will face
significant challenges in improving financial and management controls,
management processes, business and management information systems and procedures
on a timely basis and expanding, training and managing its work force. There can
be no assurance that the Company will be able to perform such actions
successfully. In the future, the Company may make additional acquisitions of
complementary companies, products or technologies. Managing an acquired business
entails numerous operational and financial risks, including difficulties in
assimilating acquired operations and new personnel, diversion of management's
attention to other business concerns, amortization of acquired intangible assets
and potential loss of key employees or customers of acquired operations. The
Company's success will depend, to a significant extent, on the ability of its
executive officers and other members of senior management to respond to these
challenges effectively. There can be no assurance that the Company will be able
to effectively achieve and manage any such growth, or that its management,
personnel or systems will be adequate to support the Company's operations. Any
such inabilities or inadequacies would have a material adverse effect on the
Company's business, operating results, financial condition and cash flows.
An important element of the Company's management strategy is to review
acquisition prospects that would complement the Company's existing products,
augment its market coverage and distribution ability or enhance its
technological capabilities. While the Company has no current agreements or
negotiations underway with respect to any new acquisitions, the Company may
acquire additional businesses, products or technologies in the future. Future
acquisitions by the Company could result in potentially dilutive issuances of
equity securities, the incurrence of debt and contingent liabilities and
amortization expense related to goodwill and other intangible assets, and other
changes which could materially adversely affect the Company's business,
financial condition and results of operations and/or the price of the Lam Common
Stock.
POTENTIAL VOLATILITY OF COMMON STOCK PRICE
The market price of Lam Common Stock has been volatile. Significant
fluctuations have occurred and could occur in the future in response to
variations in quarterly operating results, shortfalls in revenues or earnings
from levels expected by securities analysts and other factors such as
announcements of technological innovations or new products by the Company or by
the Company's competitors, government regulations, or developments in patent or
other proprietary rights. In addition, the stock market has in recent years
experienced significant price fluctuations. These fluctuations often have been
unrelated to the operating performance of the specific companies whose stocks
are affected. Broad market fluctuations, as well as economic conditions
generally in the semiconductor industry, may adversely affect the market price
of the Lam Common Stock.
POTENTIAL ANTI-TAKEOVER EFFECTS OF RIGHTS PLAN AND BYLAWS
On January 23, 1997, the Company adopted a Rights Plan (the Rights Plan) in
which rights were distributed as a dividend at the rate of one right for each
share of Common Stock, par value $0.001 per share, of the Company held by
stockholders of record as of the close of business on January 31, 1997 and
thereafter. In connection with the adoption of the Rights Plan, the Board of
Directors also adopted a number of amendments to the Company's Bylaws, including
amendments requiring advance notice of stockholder nominations of directors and
stockholder proposals.
The Rights Plan may have certain anti-takeover effects. The Rights Plan
will cause substantial dilution to a person or group that attempts to acquire
the Company in certain circumstances. Accordingly, the existence of the Rights
Plan and the issuance of the related rights may deter certain acquirers from
making takeover proposals or tender offers. The Rights Plan, however, is not
intended to prevent a takeover but rather is designed to enhance the ability of
the Board of Directors to negotiate with a potential acquirer on behalf of all
of the stockholders.
In addition, the Certificate of Incorporation authorizes 5,000,000 shares
of undesignated preferred stock. The Board of Directors of the Company, without
further stockholder approval, may issue this preferred stock with such terms as
the Board of Directors may determine, which could have the effect of delaying or
preventing a change in control of the Company. The issuance of preferred stock
could also adversely affect the voting power of the holders of Common Stock,
causing the loss of voting control. The Company's Bylaws and indemnity
agreements with officers and directors provide that the Company will indemnify
officers and directors against losses that they may incur in legal proceedings
resulting from their service to the Company. Moreover, Section 203 of the
Delaware General Corporation Law restricts certain business combinations with
"interested stockholders" as defined by that statute.
Consolidated Balance Sheets
(in thousands, except per share data)
See notes to consolidated financial statements.
Consolidated Statements of Operations
(in thousands, except per share data)
See notes to consolidated financial statements.
Consolidated Statements of Cash Flows
(in thousands)
See notes to consolidated financial statements.
Consolidated Statements of Stockholders' Equity
(in thousands)
See notes to consolidated financial statements.
Notes To Consolidated Financial Statements
June 30, 1997
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All intercompany accounts and transactions
have been eliminated in consolidation.
Cash Equivalents
All highly liquid investments purchased with an original maturity of three
months or less are considered to be cash equivalents.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market. The Company evaluates the need to record adjustments for impairment of
inventory on a quarterly basis. The Company's policy is to evaluate all
inventory including manufacturing raw materials, work-in-process, finished
goods, and spare parts. Inventory in excess of the Company's estimated usage
requirements is written down to its estimated net realizable value. Inherent in
the estimates of net realizable value are management estimates related to the
Company's future manufacturing schedules, customer demand, possible alternative
uses and ultimate realization of potentially excess inventory.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Equipment is
depreciated by the straight-line method over the estimated useful lives of the
assets, generally three to five years. Leasehold improvements are amortized by
the straight-line method over the shorter of the life of the related asset or
the term of the underlying lease. Amortization of equipment under capital leases
is included with depreciation.
Revenue Recognition
Sales of the Company's products are generally recorded upon shipment.
Estimated costs to be incurred by the Company related to product installation
and warranty fulfillment are accrued at the date of shipment.
Foreign Currency
The Company has foreign sales, service and manufacturing operations. With
respect to all foreign subsidiaries excluding Japan, the functional currency is
the U.S. dollar and transaction and translation gains and losses are included in
net income (loss) and have not been material in any year presented. The
functional currency of the Company's Japanese subsidiary is the Japanese yen.
Translation gains and losses related to the Japan subsidiary are included as a
component of stockholders' equity, but have not been material through June 30,
1997.
Income (Loss) Per Share
For fiscal 1997, net loss per share is calculated using the weighted
average number of shares of Lam Common Stock outstanding during the period. For
fiscal 1996 and 1995, primary net income per share is calculated using the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period. The common stock equivalents include shares
issuable upon the assumed exercise of stock options reflected under the treasury
stock method. The 6% convertible subordinated debentures were not deemed to be
common stock equivalents and, accordingly, were excluded from the calculation of
primary net income per share. Fully diluted net income per share for fiscal 1996
and 1995 reflects the assumed conversion of the Company's 6% convertible
subordinated debentures at the beginning of that period, and also adjusts net
income to reflect the exclusion of net interest expense and net amortization
expense of the debt issuance cost related to the debentures. The 6% convertible
subordinated debentures were called by the Company during the quarter ended June
30, 1996. Primary income per share, for fiscal 1996, calculated to reflect the
conversion of the 6% convertible subordinated debentures as if they were
converted on July 1, 1995 is $4.67.
In March 1997, the Financial Accounting Standards Board (FASB) released
Statement of Financial Accounting Standards No. 128 "Earnings Per Share" (FAS
128), which is required to be adopted on December 31, 1997. At that time, the
Company will be required to change the method currently used to compute earnings
per share and to restate all prior periods. Under the new requirements for
calculating primary net income per share (basic earnings per share), the
dilutive effect of stock options will be excluded. The Company's basic and
diluted earnings (loss) per share as calculated according to FAS 128 would have
been as follows:
Notes To Consolidated Financial Statements
June 30, 1997
Employee Stock Plans
The Company accounts for its stock option plans and its employee stock
purchase plan in accordance with the provisions of the Accounting Principles
Board's Opinion No. 25 "Accounting For Stock Issued to Employees" (APB 25). In
October 1995, the FASB released Statement of Financial Accounting Standard No.
123, "Accounting For Stock-Based Compensation" (FAS 123) which provides an
alternative to APB 25. As allowed under FAS 123, the Company continues to
account for its employee stock plans in accordance with the provisions of APB
25. See note J.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that could affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
Transfer of Financial Assets
During fiscal 1997, the Company adopted Statement of Financial Accounting
Standard No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" (FAS 125), which requires the Company to
recognize the financial and servicing assets it controls and the liabilities it
has incurred and to derecognize financial assets when control has been
surrendered in accordance with criteria provided. FAS 125 is required to be
applied to sales of receivables by the Company occurring after January 1, 1997.
The effect of adopting FAS 125 for the six months ended June 30, 1997 was not
material.
Capital Structure
In February 1997, the FASB released Statement of Financial Accounting
Standards No. 129, "Disclosure of Information about Capital Structure" (FAS
129). FAS 129 consolidates the existing guidance regarding disclosure relating
to a company's capital structure and is effective for fiscal years beginning
after December 15, 1997. Adoption of FAS 129 is not expected to have a material
impact on the Company's consolidated financial statements.
Comprehensive Income
In June 1997, the FASB released Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" (FAS 130). FAS 130 establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general purpose financial statements and is
effective for fiscal years beginning after December 15, 1997. The Company
believes that adoption of FAS 130 will not have a material impact on the
Company's consolidated financial statements.
Segment Information
In June 1997, the FASB released Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
(FAS 131). FAS 131 will change the way companies report selected segment
information in annual financial statements and also requires those companies to
report selected segment information in interim financial reports to
stockholders. FAS 131 is effective for fiscal years beginning after December 15,
1997. Based on the current circumstances, the Company believes that the
application of the new rules will not have a material impact on the Company's
consolidated financial statements.
NOTE B: COMPANY AND INDUSTRY INFORMATION
Lam is a leading supplier of technically complex thin film processing
equipment used in the primary stages of semiconductor manufacturing. The
Company's product offerings include single wafer plasma etch systems with a wide
range of applications and CVD, CMP and FPD systems. The Company sells its
products primarily to large companies involved in the production of
semiconductors in the United States, Europe, Japan and Asia Pacific. Credit
evaluations are performed on all customers, and the Company usually does not
require collateral on sales.
The semiconductor industry has historically been cyclical and has
experienced periodic downturns, which have had a material adverse effect on the
semiconductor industry's demand for semiconductor processing equipment,
including equipment manufactured and marketed by the Company. Certain of the
components and subassemblies included in the Company's products are obtained
from a single supplier or a limited group of suppliers. The Company believes
that alternative sources could be obtained and qualified to supply these
products. Nevertheless, a prolonged inability to obtain certain components could
have a severe near term effect on the Company's operating results and could
result in damage to customer relationships.
The Company entered into agreements totaling 9 billion yen and 6 billion
yen, respectively, in fiscal 1997 and 1996 to sell specific Japanese yen-
denominated receivables subject to recourse provisions. At June 30, 1997 and
1996, $59,986,000 and $82,104,000, of these receivables,
Notes To Consolidated Financial Statements
June 30, 1997
respectively, had been sold to a bank, of which $39,924,000 and $49,467,000 at
June 30, 1997 and 1996, respectively, remained uncollected by the bank and
subject to recourse provisions.
During fiscal 1997 and 1996, no individual customer accounted for greater
than 10% of total sales. One customer accounted for 11% of total sales in fiscal
1995.
The Company operates in four geographic regions, the United States, Europe,
Japan and Asia Pacific. The following is a summary of local operations by
geographic region at June 30:
Sales between geographic areas are accounted for at prices that provide a
profit and are in accordance with the rules and regulations of the respective
governing authorities. Total export revenue consisting of sales from the
Company's U.S. operating subsidiary to non-affiliated customers by geographic
region for the three years ended June 30 are as follows:
NOTE C: FINANCIAL INSTRUMENTS
In November 1995, the FASB staff issued a Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities". In accordance with provisions in that Special Report,
the Company elected, in December 1995, to reclassify all of its held-to-maturity
securities to available-for-sale. At the time of transfer, the amortized cost of
those securities was $24,099,000, which approximated their fair value.
Investments at June 30 are comprised of the following:
The difference between cost and fair value of available-for-sale securities
was not significant at June 30, 1997 and 1996.
The amortized cost and estimated fair value of investments in debt
securities at June 30 by contractual maturities are as follows:
Notes To Consolidated Financial Statements
June 30, 1997
The carrying and fair values of the Company's financial instruments at June
30, are as follows:
The fair values of the Company's short-term investments are based on quoted
market prices at June 30, 1997 and 1996. The fair value of the Company's foreign
currency forward contracts is estimated based upon the yen exchange rate at June
30, 1997 and 1996. The fair value of the Company's other long-term debt is
estimated based on the current rates offered to the Company for similar debt
instruments of the same remaining maturities.
NOTE D: DERIVATIVE FINANCIAL INSTRUMENTS
The Company enters into foreign-currency forward contracts to minimize the
impact of exchange rate fluctuations on the value of yen-denominated assets and
liabilities. A substantial portion of the forward contracts entered into have a
maturity of 90 days or less. The realized and unrealized gains and losses on
these contracts are deferred and offset against realized and unrealized gains
and losses from the settlement of the related yen receivables. The realized
losses on yen-forward contracts during fiscal 1997 were offset by gains on the
underlying receivables.
At June 30, 1997 and 1996, the notional amount of outstanding foreign
currency forward contracts were $30,651,000 and $44,580,000, respectively. Of
the total outstanding contracts at June 30, 1997 and 1996, $13,828,000 and
$38,794,000, respectively, were to hedge yen intercompany receivables and
$17,776,000 and $4,838,000, respectively, were to hedge firm commitments from
customers in Japan. The unrealized loss on these contracts at June 30, 1997 was
$953,000. The unrealized gain on these contracts at June 30, 1996 was $948,000.
NOTE E: INVENTORIES
Inventories consist of the following at June 30:
NOTE F: PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other assets consist of the following at June 30:
During fiscal 1997, the Company recorded bad debt expense of $6,550,000
relating to the former at-risk receivables from SubMicron. The estimated net
realizable value of the collateral which the Company holds related to these
receivables has been included in prepaid expenses and other assets.
NOTE G: EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following at June 30:
Notes To Consolidated Financial Statements
June 30, 1997
NOTE H: ACCRUED EXPENSES AND OTHER LIABILITIES
The significant components of accrued expenses and other liabilities
consist of the following at June 30:
NOTE I: LINE OF CREDIT, LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations at June 30 consist of the
following:
During the second quarter of fiscal 1996, the Company entered into a
syndicated bank line of credit totaling $210,000,000, under which borrowings
bear interest at the bank's prime rate or 0.7% to 0.9% over LIBOR. This
syndicated bank line of credit expires in December 1998. At June 30, 1997 and
1996, the Company had outstanding borrowings of $35,000,000 and $25,000,000,
respectively, against the syndicated bank line of credit. The credit agreement
includes terms requiring satisfaction of certain financial ratios, interest
coverage, maximum leverage, senior indebtedness, tangible net worth, minimum
profitability and also restricts the Company from paying dividends. During the
third quarter of fiscal 1997, the Company received amendments or waivers for
certain of its financial covenants which would have otherwise been breached by
the net loss reported by the Company. At June 30, 1997, the Company was in
compliance with all of its covenants as amended.
At June 30, 1997, future maturities of long-term debt and minimum payments
for capital lease obligations are as follows:
Long-term debt and capital lease obligations are collateralized by
equipment included in equipment and leasehold improvements with a cost and
accumulated depreciation and amortization of $56,671,000 and $(22,698,000),
respectively, at June 30, 1997 and $45,484,000 and $(15,309,000), respectively,
at June 30, 1996.
NOTE J: INCENTIVE STOCK OPTION PLANS AND STOCK PURCHASE PLAN
The Company has adopted incentive stock option plans that provide for the
granting to qualified employees of incentive stock options to purchase shares of
Lam Common Stock. In addition, the plans permit the granting of nonstatutory
stock options to consultants and employees and provides for the automatic grant
of nonstatutory stock options to outside directors. The option price is
determined by the Board of Directors, but in no event will it be less than the
fair market value on the date of grant (no less than 85% of the fair market
value at the date of grant in case of nonstatutory options). Options granted
under the plans vest over a period determined by the Board of Directors. Under
the automatic grant program, each outside director receives an option
exercisable for 6,000 shares of Lam Common Stock during January of each year
with the exercise price equal to the fair market value on date of grant.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1997
A summary of incentive stock option plan transactions follows:
Outstanding and exercisable options presented by price range at June 30,
1997 are as follows:
Notes To Consolidated Financial Statements
June 30, 1997
At June 30, 1997, 3,455,468 shares of Lam Common Stock were reserved for
future issuance under the stock option plans and options to purchase 1,560,249
shares were exercisable at a range of $5.25-$62.88 per share.
During fiscal 1996, the Company adopted a Performance-Based Restricted
Stock Plan designed to reward executives based upon the achievement of certain
predetermined goals. The grant is based on the fair market value of Lam Common
Stock at the end of the quarter, provided the predetermined goals are met. The
Company authorized 150,000 shares to be reserved for issuance under the
Performance-Based Restricted Stock Plan. At June 30, 1997, 120,879 shares remain
available under this plan.
Lam Common Stock is sold to employees under the 1984 Employee Stock
Purchase Plan (ESPP). During fiscal 1996, the Company authorized an additional
150,000 shares to be reserved for issuance under the 1984 ESPP. The purchase
price per share is the lower of 85% of the fair market value of the Lam Common
Stock on the first or last day of a six-month offering period. A total of
1,348,873 shares of Lam Common Stock was issued under the ESPP through June 30,
1997 at prices ranging from $2.65 to $43.03 per share. At June 30, 1997, 338,627
shares remain available for sale under the ESPP.
As permitted under FAS 123, the Company has elected to follow APB 25 and
related Interpretations, in accounting for stock-based awards to employees.
Under APB 25, the Company generally recognized no compensation expense with
respect to such awards.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by FAS 123 for awards granted after June 30, 1995 as if the
Company had accounted for its stock-based awards to employees under the fair
value method of FAS 123. The fair value of the Company's stock-based awards to
employees was estimated using a Black-Scholes option pricing model. The Black-
Scholes option valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable. In addition, the Black-Scholes model requires the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock-based awards to employees have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards to employees. The fair value
of the Company's stock-based awards to employees was estimated assuming no
expected dividends and the following weighted-average assumptions:
The weighted average fair value of options granted during fiscal 1997 and
1996 was $11.52 and $13.88 per share, respectively. The weighted average fair
value of shares granted under the ESPP during fiscal 1997 and 1996 was $7.65 and
$9.76 per share, respectively.
For pro forma purposes, the estimated fair value of the Company's stock-
based awards to employees is amortized over the options' vesting period (for
options) and the six-month purchase period (for stock purchases under the ESPP).
The Company's pro forma information follows:
FAS 123 is applicable only to awards granted subsequent to June 30, 1995.
As a result, its pro forma effect will not be fully reflected until fiscal 1999.
NOTE K: PROFIT SHARING PLAN AND BENEFIT PLAN
During fiscal 1995, the Company revised the profit sharing plan for its
domestic employees. Distributions to employees by the Company are made quarterly
based upon a percentage of base salary provided that a threshold level of the
Company's financial and performance goals are met. Upon achievement of the
threshold, the profit sharing is awarded based upon performance against certain
corporate financial and operating goals. Prior to fiscal 1995, distributions to
the domestic employees under the profit sharing plan were made semi-annually
based on 5% of pretax income provided certain minimum net income goals were
Notes To Consolidated Financial Statements
June 30, 1997
met. In fiscal 1997, the Company did not incur profit sharing plan expense.
Profit sharing plan expense for fiscal 1996 and 1995 was $14,438,000 and
$9,506,000, respectively.
The Company maintains a 401(k) retirement savings plan for its full-time
domestic employees. Each participant in the plan may elect to contribute 2% to
15% of his or her annual salary to the plan, subject to statutory limitations.
Prior to October 1, 1995, each participant could elect to contribute 2% to 20%
of his or her annual salary to the plan, subject to statutory limitations. The
Company matches employee contributions to the plan at the rate of 50% of the
first 6% of salary contributed. The Company match expense for fiscal 1997, 1996
and 1995 was $4,417,000, $3,754,000, and $2,342,000 respectively.
NOTE L: COMMITMENTS
The Company leases its administrative, R&D, and manufacturing facilities,
regional customer support offices and certain equipment under noncancelable
operating leases, which expire at various dates through 2020. Certain of the
Company's labs and other equipment are also supplied under operating leases. All
of the Company's facility leases for buildings located at its Fremont,
California headquarters and certain operating leases provide the Company an
option to extend the leases for additional periods. Certain of the Company's
other facility leases provide for periodic rent increases based on the general
rate of inflation.
Future minimum lease payments for the years ended June 30 and in the
aggregate under operating leases consist of the following:
During fiscal 1996, the Company entered into a ten year operating lease
agreement for two buildings, an R&D building and an additional engineering
building, which requires the Company to set aside approximately $47,900,000 as
lease collateral five years after lease inception.
Total rental expense for all leases amounted to approximately $45,656,000,
$35,303,000, and $9,528,000, for the years ended June 30, 1997, 1996 and 1995,
respectively.
The Company has subleased some of its buildings and will receive income of
approximately $1,914,000, $2,442,000, $2,448,000, $2,293,000, $1,978,000 and
$471,000 for fiscal 1998, 1999, 2000, 2001, 2002 and thereafter, respectively,
which will offset minimum lease payments.
For the fiscal year ended June 30, 1997, the Company recorded income
totaling $405,000 on its subleased facilities.
NOTE M: LICENSING/ROYALTY AGREEMENTS
The Company receives royalty income from TEL under a licensing agreement
signed in fiscal 1987 and extended in fiscal 1992 and 1996. For the years ended
June 30, 1997, 1996 and 1995, the Company earned approximately $11,700,000,
$20,700,000, and $10,500,000, respectively, of royalty income from TEL. The
current royalty agreement, which was set to expire December 31, 1996, was
renegotiated at a reduced royalty rate (5% to 1%) which went into effect
January 1, 1997.
The Company also receives royalty income from Sumitomo. Royalty income
earned from Sumitomo for fiscal 1997, 1996 and 1995 amounted to approximately
$1,000,000, $2,100,000, and $1,700,000, respectively.
During fiscal 1995, the Company earned approximately $100,000 of royalty
income from other sources.
NOTE N: INCOME TAXES
Income tax expense (benefit) consists of the following:
Actual current tax benefits are higher than reflected above for fiscal 1997
by $1,039,000 and actual current tax liabilities are lower than tax expense
reflected above for fiscal years 1996 and 1995 by $1,719,000 and $7,128,000,
respectively, for the stock option deduction benefits recorded as a credit to
stockholders' equity.
Under FAS No. 109, deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
Notes To Consolidated Financial Statements
June 30, 1997
purposes. Significant components of the Company's net deferred tax assets as of
June 30, are as follows:
A reconciliation of income tax expense provided at the federal statutory
rate (35% in 1997, 1996 and 1995) to income tax expense follows:
Income before income taxes from foreign operations for fiscal years 1997,
1996 and 1995 was $31,621,000, $42,216,000, and $17,830,000, respectively. In
addition, the Company received royalty and other income from foreign sources of
$12,662,000, $22,814,000 and $12,227,000, in fiscal years 1997, 1996 and 1995,
respectively, which is subject to foreign tax withholding.
NOTE O: RESTRUCTURING
During the first quarter of fiscal 1997, the Company restructured its
operations by consolidating its previous business unit structure into a more
centralized functional organization. As a result of the restructuring, and in
response to industry and market conditions, the Company reduced its work force
by approximately 11%. The Company recorded a restructuring charge of $9.0
million for costs related primarily to severance compensation and consolidation
of facilities. At June 30, 1997, $1.7 million remains in accrued liabilities
relating primarily to executive severance and remaining lease payments on unused
facilities. As of June 30, 1997, the Company had made $6.3 million of cash
payments relating to the restructuring.
NOTE P: RIGHTS PLAN
On January 23, 1997, the Company adopted a Rights Plan (the Rights Plan).
Pursuant to the Rights Plan, rights were distributed as a dividend at the rate
of one right for each share of Lam Common Stock, par value $0.001 per share
(Right), of the Company held by stockholders of record as of the close of
business on January 31, 1997 and thereafter. The Rights will expire on January
31, 2007, unless redeemed or exchanged. Under the Rights Plan, each Right
initially will entitle the registered holder to buy one unit of a share of
preferred stock for $250.00. The Rights will become exercisable only if a person
or group (other than stockholders currently owning 15% of Lam Common Stock)
acquires beneficial ownership of 15% or more of Lam Common Stock or commences a
tender or exchange offer upon consummation of which such person or group would
beneficially own 15% or more of Lam Common Stock.
NOTE Q: RELATED PARTY TRANSACTION
During fiscal 1997, the Company invested $4.0 million for a 32% interest in
a limited partnership (the Partnership). The Partnership was organized for the
purpose of investing in emerging technology companies to seek income and gains
to the Partnership. Three of the Company's directors are principals in the
limited liability company that is the general partner of the Partnership. The
Company is accounting for its investment in the Partnership under the equity
method. Accordingly, the Company will adjust the recorded value of its
investment for its share (32%) of the Partnership's net income or loss. The
Company's portion of the Partnership's net income was not material for the year
ended June 30, 1997.
NOTE R: LITIGATION
In October 1993, Varian Associates, Inc. (Varian) brought suit against the
Company in the United States District Court, Northern District of California,
seeking monetary damages and injunctive relief based on the Company's alleged
infringement of certain patents held by Varian. The lawsuit is in the late
stages of discovery and has been reassigned to a new judge. The trial date has
been set for March 1998. The Company has asserted defenses of invalidity and
unenforceability of the patents that are the subject of the lawsuit, as well as
noninfringement of such patents by the Company's products. While litigation is
subject to inherent uncertainties and no assurance can be given that the Company
will prevail in such litigation or will obtain a license under such patents on
commercially
Notes To Consolidated Financial Statements
June 30, 1997
reasonable terms or at all if such patents are held valid and infringed by the
Company's products, the Company believes that the Varian lawsuit will not have a
material adverse effect on the Company's consolidated financial statements.
In addition, the Company is from time to time notified by various parties
that it may be in violation of certain patents. In such cases, it is the
Company's intention to seek negotiated licenses where it is considered
appropriate. The outcome of these matters will not, in management's opinion,
have a material impact on the Company's consolidated financial position,
operating results or cash flow statements.
NOTE S: SUBSEQUENT EVENT--ONTRAK MERGER (UNAUDITED)
On August 5, 1997, the stockholders of the Company approved the issuance of
Lam Common Stock under the Agreement and Plan of Merger with OnTrak. The Company
will issue approximately 8,759,000 shares of Lam Common Stock for all the
outstanding common stock and options and rights to purchase OnTrak Common Stock
on the basis of 0.83 of a share of Lam Common Stock for one share of OnTrak
Common Stock. The transaction will be accounted for as a pooling of interests
and is structured to qualify as a tax-free reorganization. The anticipated
financial impact of the conforming accounting methods is not expected to be
material to the financial position of the Company. The Company estimates that
costs associated with the Merger were approximately $17.7 million. Such expenses
include investment advisory fees, legal and accounting fees, financial printing
costs and other Merger related costs. Such costs associated with the Merger will
negatively impact results of operations in the fiscal quarter ended September
30, 1997.
The following summary, prepared on a pro forma basis, combines the results
of operations of the Company and OnTrak as if the Merger had been effective as
of the beginning of the fiscal periods presented below:
NOTE T: SUBSEQUENT EVENT--APPROVAL OF LAM RESEARCH CORPORATION 1997 STOCK
INCENTIVE PLAN
On August 5, 1997, the stockholders of the Company approved the Lam
Research Corporation 1997 Stock Incentive Plan, which will provide for the grant
of stock options, restricted stock, deferred stock and performance share awards
to participating officers, directors, employees, consultants and advisors of the
Company and its subsidiaries. Initially, 3,000,000 shares were reserved for
issuance. The number of shares to be issued will automatically be increased each
calendar quarter subject to certain provisions and restrictions but in no event
exceed 5,000,000 shares.
NOTE U: SUBSEQUENT EVENT--CONVERTIBLE SUBORDINATED NOTES
During August 1997, Lam completed an offering of $310.0 million of
Convertible Subordinated Notes (the Notes). The Notes bear interest at five
percent, mature on September 1, 2002 and are convertible into shares of Lam's
Common Stock at $87.77 per share. Expenses associated with the offering of
approximately $9.0 million will be deferred and will be included in other
assets. Such expenses will be amortized to interest expense over the term of the
Notes.
In connection with the issuance of the Notes, the Company received consents
and waivers with respect to certain financial and other covenants contained in
agreements related to certain existing financial arrangements. In addition, as a
consequence of the Merger with OnTrak as well as issuance of the Notes, the
Company, on or prior to the end of the fiscal quarter ending September 30, 1997,
would be out of compliance with certain other financial covenants unless
appropriate waivers are completed prior to that time. The Company is currently
in discussions with lenders that are parties to these agreements. Based on these
discussions, the Company believes that appropriate amendments or waivers will
be obtained prior to fiscal quarter end on terms no less favorable to the
Company than the existing terms. In the event any such amendments or waivers
are not obtained by fiscal quarter end, the Company could be required to
terminate the revolving credit facility, purchase certain of its leased
facilities, purchase sold receivables and pay certain of the Japanese term
loans.
Report of Ernst & Young LLP, Independent Auditors
Board of Directors
Lam Research Corporation
Fremont, California
We have audited the accompanying consolidated balance sheets of Lam
Research Corporation as of June 30, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended June 30, 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Lam Research
Corporation at June 30, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
San Jose, California
August 26, 1997