1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended November 22, 1998
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________
COMMISSION FILE NUMBER 0-10558
ALPHA MICROSYSTEMS
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-3108178
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2722 S. FAIRVIEW STREET, SANTA ANA, CA 92704
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (714) 957-8500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of December 30, 1998, there were 11,193,952 shares of the registrant's Common
Stock outstanding.
2
ALPHA MICROSYSTEMS
TABLE OF CONTENTS
PAGE NUMBER
-----------
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at November 22, 1998 (Unaudited) and
February 22, 1998 3
Condensed Consolidated Statements of
Operations (Unaudited) for the Three
and Nine Months Ended November 22, 1998 and
November 23, 1997 4
Condensed Consolidated Statements of Cash Flows
(Unaudited) for the Nine Months Ended November 22, 1998
and November 23, 1997 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
PART II-- OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security-Holders 17
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
EXHIBIT INDEX 20
-2-
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALPHA MICROSYSTEMS
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
November 22, February 22,
1998 1998
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 5,680 $ 5,003
Accounts receivable, net of allowance for
doubtful accounts of $728 and $294 at
November 22, 1998 and February 22, 1998,
respectively 6,599 3,781
Inventories 1,090 580
Prepaid expenses and other current assets 637 390
-------- --------
Total current assets 14,006 9,754
Property and equipment, net of accumulated
depreciation of $9,103 and $9,479 at
November 22, 1998 and February 22, 1998,
respectively 3,422 3,186
Goodwill, net 7,676 --
IT Service contracts, net 484 1,192
Software costs, net 521 1,067
Other assets, net 435 589
-------- --------
$ 26,544 $ 15,788
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,654 $ 1,699
Deferred revenue 3,277 1,888
Bank borrowings 250 1,000
Accrued compensation 866 386
Other current liabilities 1,097 356
Current portion of long-term debt 116 92
-------- --------
Total current liabilities 9,260 5,421
Long-term debt 724 60
Commitments and contingencies
Redeemable preferred stock, no par
value; 5,000,000 shares authorized;
15,001 issued and outstanding
at November 22, 1998;
liquidation value $15,159 12,920 --
Common stock, no par value; 40,000,000
shares authorized; 11,193,952 and
10,914,112 shares issued and
outstanding at November 22, 1998 and
February 22, 1998, respectively 31,315 31,011
Warrants 1,704 --
Accumulated deficit (29,389) (20,761)
Foreign currency translation adjustment 10 57
-------- --------
$ 26,544 $ 15,788
======== ========
See accompanying notes.
-3-
4
ALPHA MICROSYSTEMS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
---------------------------- ---------------------------
November 22, November 23, November 22, November 23,
1998 1997 1998 1997
-------------- ------------- ------------ --------------
Net sales:
IT Services $ 7,883 $ 3,370 $16,574 $ 9,609
Product 1,200 1,748 3,644 4,659
------- ------- ------- -------
Total net sales 9,083 5,118 20,218 14,268
------- ------- ------- -------
Cost of sales:
IT Services 6,689 2,456 14,363 6,914
Product 1,702 1,161 3,398 3,183
------- ------- ------- -------
Total cost of sales 8,391 3,617 17,761 10,097
------- ------- ------- -------
Gross margin 692 1,501 2,457 4,171
Operating expenses:
Selling, general and administrative 3,640 1,897 6,950 5,895
Engineering, research and development 375 357 1,011 1,101
Impairment of long-lived assets 2,438 -- 2,438 --
------- ------- ------- -------
Total operating expenses 6,453 2,254 10,399 6,996
------- ------- ------- -------
Loss from operations (5,761) (753) (7,942) (2,825)
Other (income) expense:
Interest income (17) (61) (61) (241)
Interest expense 43 1 95 6
Other expense, net 382 13 413 25
Foreign exchange (gain) loss (3) (19) (39) (2)
------- ------- ------- -------
Total other (income) expense 405 (66) 408 (212)
------- ------- ------- -------
Loss before taxes (6,166) (687) (8,350) (2,613)
Provision for income taxes 1 1 14 10
------- ------- ------- -------
Net loss $(6,167) $ (688) $(8,364) $(2,623)
======= ======= ======= =======
Basic and diluted net loss per share $ (0.57) $ (0.06) $ (0.78) $ (0.24)
======= ======= ======= =======
Number of shares used in the computation
of basic and diluted per share amounts 11,188 10,887 11,011 10,848
======= ======= ======= =======
See accompanying notes
-4-
5
ALPHA MICROSYSTEMS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended
---------------------------
November 22, November 23,
1998 1997
------------ ------------
Cash flows from operating activities:
Net loss $ (8,364) $ (2,623)
Adjustments to reconcile net loss to cash
used in operating activities:
Impairment of long-lived assets 2,438 --
Software obsolescence 666 --
Depreciation and amortization 1,721 1,238
Loss on sale of subsidiary 379 --
Provision for losses on accounts receivable 548 35
Provision for slow-moving inventory 72 55
Other changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable (1,219) (733)
Inventories 159 (150)
Prepaid expenses and current assets 53 145
Accrued compensation 115 (168)
Accounts payable and accrued liabilities (91) (12)
Deferred revenue (52) (62)
Other, net (34) 32
-------- --------
Net cash used in operating activities (3,609) (2,243)
Cash flows from investing activities:
Acquisition of DCI, net of cash acquired (3,667) --
Acquisition of other IT Service assets (478) (70)
Purchases of equipment (1,428) (488)
Capitalization of software costs (233) (586)
Purchase of intangible assets -- (65)
Purchase of short-term investments -- (7,405)
Proceeds from sale of short-term investments -- 10,387
-------- --------
Net cash (used in) provided by
investing activities (5,806) 1,773
Cash flows from financing activities:
Issuance of preferred stock, net 12,872 --
Payment of preferred stock dividends (58) --
Issuance of warrants to purchase common stock, net 1,704 --
Issuance of common stock 277 53
Issuance of debt 1,000 --
Principal repayments on debt (1,080) (10)
Repayments on debt assumed in acquisition of DCI (4,612) --
-------- --------
Net cash provided by financing activities 10,103 43
Effect of exchange rate changes on cash (11) (4)
-------- --------
Net increase (decrease) in cash and cash equivalents 677 (431)
Cash and cash equivalents at beginning of period 5,003 1,768
-------- --------
Cash and cash equivalents at end of period $ 5,680 $ 1,337
======== ========
See accompanying notes.
-5-
6
ALPHA MICROSYSTEMS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM ACCOUNTING POLICY
In the opinion of management of Alpha Microsystems (the "Company" or "Alpha
Micro"), the accompanying unaudited condensed consolidated financial statements
contain all adjustments necessary (which, except for the operating charges
discussed in Note 6, consist only of normal recurring adjustments) to fairly
present the consolidated financial position of the Company at November 22, 1998,
and the consolidated results of its operations for the three- and nine-month
periods ended November 22, 1998 and November 23, 1997, and its cash flows for
the nine-month periods ended November 22, 1998 and November 23, 1997. These
condensed consolidated financial statements do not include all disclosures
normally presented annually under generally accepted accounting principles and,
therefore, they should be read in conjunction with the Company's annual report
on Form 10-K for the year ended February 22, 1998. Certain prior period amounts
have been reclassified to conform to the current period presentation. The
results of operations for the periods ended November 22, 1998 are not
necessarily indicative of the results to be expected for any future period.
FISCAL YEAR
Historically, the Company's fiscal year ended in the month of February. On
December 17, 1998, the Company's Board of Directors approved a change in the
Company's fiscal year to a calendar year-end. The Company intends to file a
Transition Report on Form 10-K on or before March 31, 1999.
REVENUE RECOGNITION
The Company recognizes revenue on its product sales on shipment, and recognizes
revenue on its IT service sales and post contract customer support on a
straight-line basis over the contract period. When significant obligations
remain after a software product has been delivered, revenue is not recognized
until obligations have been completed or are no longer significant. The costs of
any insignificant obligations are accrued when the related revenue is
recognized. Revenue is recognized only when collection of the resulting
receivable is probable.
PER SHARE INFORMATION
Basic and diluted earnings per share is based on the weighted average common
shares outstanding during the periods presented and excludes the anti-dilutive
effects of options and warrants. The net loss has also been adjusted to reflect
dividends earned and accretion related to redeemable preferred shares
outstanding, as shown below:
Three Months Ended Nine Months Ended
------------------------------ ----------------------------
November 22, November 23, November 22, November 23,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Net loss $(6,167) $ (688) $(8,364) $(2,623)
Accretion on redeemable preferred stock (48) -- (48) --
Dividends on redeemable preferred stock (217) -- (217) --
------- ------ ------- -------
Net loss to common shareholders $(6,432) $ (688) $(8,629) $(2,623)
======= ====== ======= =======
-6-
7
COMPREHENSIVE INCOME
As of February 22, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's results of operations or shareholders' equity. SFAS 130 requires
foreign currency translation adjustments, which prior to adoption were reported
separately in shareholders' equity, to be included in other comprehensive
income. For the nine months ended November 22, 1998 and November 23, 1997, total
comprehensive loss amounted to $8,411,000 and $2,636,000, respectively.
2. INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined on the
first-in, first-out method, or weighted average cost, which approximates FIFO.
Inventories, net of reserves for excess and obsolete inventories of $138,000 and
$98,000 at November 22, 1998 and February 22, 1998, respectively, comprise the
following:
(In thousands)
November 22, February 22,
1998 1998
------------ -----------
Raw materials $ 378 $ 568
Work in process 3 4
Finished goods 709 8
------ -----
$1,090 $ 580
====== =====
3. ACQUISITION OF DELTA COMPUTEC INC.
On September 1, 1998, the Company completed the acquisition of Delta CompuTec
Inc ("DCI"). DCI provides management and consulting services, as well as
services that include network design, installation and maintenance. The
Agreement and Plan of Merger ("Merger Agreement") provided for the payment of
$3.4 million in exchange for all of the outstanding shares of DCI at the time of
closing, and a net payment of DCI's then outstanding debt in the amount of $4.6
million. Under the Merger Agreement, DCI became a wholly-owned subsidiary of
Alpha Micro. The acquisition was accounted for as a purchase and is reflected in
the pro forma information below based upon available information and upon
certain assumptions that the Company believes are reasonable in the
circumstances. The Company's initial purchase price allocation is preliminary
and subject to change as the Company obtains all the information necessary to
complete the allocation process.
-7-
8
The pro forma financial information below reflects the acquisition of DCI and
the related purchase price financing through the sale of redeemable preferred
stock, warrants and term loan borrowings as if the acquisition occurred at the
beginning of the period presented below.
Nine-month Nine-month
period ended period ended
November 22, 1998 November 23, 1997
----------------- -----------------
Revenue $27,586 $23,948
======= =======
Net loss $(8,002) $(1,847)
======= =======
Basic and diluted net loss
per common share $ (0.79) $ (0.23)
======= =======
4. ACQUISITION TERM LOAN
A portion of the DCI acquisition was financed with $1.0 million of cash proceeds
under a four-year term loan provided by its bank. The term loan facility
provides for interest to be payable at the bank prime rate plus 2.5% (11% as of
the acquisition date) and is subject to certain financial covenants including
tangible net worth, debt to tangible net worth and quick ratio minimum
requirements.
5. SALE OF PREFERRED STOCK AND WARRANTS
In addition to the $1.0 million of cash proceeds provided under a four year bank
term-loan (see above), the acquisition of DCI was financed with $8.0 million
obtained under a Securities Purchase Agreement (the "Purchase Agreement"). Under
the Purchase Agreement, ING Equity Partners II, L.P. ("ING") agreed, subject to
certain conditions, to invest up to $20 million in redeemable exchangeable
preferred stock (the "Redeemable Preferred Stock") of the Company. The Purchase
Agreement provides for the purchase of Redeemable Preferred Stock, Voting
Preferred Stock, and Warrants by ING in three tranches of $8 million, $7
million, and up to $5 million, respectively. The first tranche was completed
concurrent with the acquisition of DCI and the second tranche was funded on
October 20, 1998 after shareholder approval. The Redeemable Preferred Stock was
initially recorded net of $1,754,000, which is the estimated fair value of the
warrants issued, determined through independent appraisal, and direct costs
associated with issuance aggregating approximately $374,000. The difference
between the initial carrying value of the Redeemable Preferred Stock of
$12,872,000 and $15,000,000 is being accreted through periodic charges to
accumulated deficit. Such accretion aggregated $48,000 during the periods ended
November 22, 1998.
Dividends are payable on the Redeemable Preferred Stock purchased by ING at an
initial 9% cumulative annual dividend rate, which increases to 11% on July 1,
2000 and thereafter increases an additional 1% annually. Dividends aggregating
$217,000 were charged, of which $58,000 was paid, to accumulated deficit for the
periods ended November 22, 1998.
In connection with ING's $15 million investment in Redeemable Preferred Stock,
ING was granted warrants to purchase 5,833,188 shares of the Company's common
stock for $2.50 per share. If the Company elects to close the third tranche,
subject to certain conditions, ING will invest up to an additional $5 million,
the proceeds from which must be used for certain acquisitions. In such event,
ING will be granted warrants to purchase for $2.50 per share additional shares
of common stock which, together with previously issued warrants will total up to
8,753,626 shares. The third closing must occur, if at all, on or before June 30,
1999.
-8-
9
There is no assurance that the third tranche of the ING transaction will be
consummated. If the Company elects to redeem the Redeemable Preferred Stock
prior to June 30, 2000, the shares purchasable pursuant to the Warrants will be
reduced by approximately 600,000 shares, assuming all three tranches are closed.
6. OPERATING CHARGES
Significant to the comparative results of operations are charges totaling
$4,615,000 in the most recent quarter. These charges are comprised of the
following: (i) $2,230,000 to write-down impaired tangible and intangible assets
from non-core business acquired prior to 1998 to their estimated fair values
based on estimated cash flows, and write-down of accounts receivable related to
non-core operations, (ii) $910,000 to write-down impaired fixed assets and
inventory related to end-of-life proprietary product lines to their estimated
fair values, (iii) $749,000 related to software products obsolesced by the
introduction of new products, (iv) $379,000 resulting from the write-off of
notes receivable from previously sold assets and subsidiaries, (v) $256,000 of
indirect financing costs related to the sale of redeemable preferred stock and
warrants and the expensing of previously capitalized costs associated with
abandoned acquisitions, and (vi) $91,000 in write-offs of costs related to Year
2000 issues and adjustments of warranty and other liabilities. The table below
summarizes where these charges have been recognized on the statement of
operations for the periods ended November 22, 1998 (in thousands):
Cost of Operating Impairment
Sales Expenses Charge Other Total
------- --------- ---------- ------- -------
Impairment of tangible and
intangible assets $ 147 $ 495 $ 1,588 $ -- $2,230
Write-down of fixed assets and
inventory 60 -- 850 -- 910
Software obsolescence 666 83 -- -- 749
Loss on sale of assets and
subsidiaries -- -- -- 379 379
Indirect financing costs -- 256 -- -- 256
Year 2000 issues and operating
expenses 25 66 -- -- 91
----- ----- ------- ---- ------
Total $ 898 $ 900 $ 2,438 $379 $4,615
===== ===== ======= ==== ======
7. CONTINGENCIES
The Company's current involvement with litigation is as follows:
In December 1995, Phoenix Marketing, Inc. d.b.a. Electronic Business Systems,
Inc., in response to the Company's collection efforts for a past due account,
filed an amended cross-complaint alleging damages of $3,200,000 for defective
merchandise, loss of business reputation and loss of future business. The case
was consensually settled, with the settlement funded entirely by the Company's
insurance carrier.
The Company is currently involved in certain other claims and litigation. The
Company does not consider any of these other claims or litigation to be
material. Management has made provisions in the Company's financial statements
for the settlement of lawsuits for which unfavorable outcomes are both probable
and estimable. In the opinion of management, results of known existing claims
and litigation will not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
-9-
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains certain forward-looking statements
(as such term is defined in the private Securities Litigation Reform Act of 1995
(the "Reform Act")) and information relating to Alpha Microsystems (the
"Company" or "Alpha Micro") that are based on the beliefs of the management of
the Company as well as assumptions made by and information currently available
to the management of Alpha Micro, and the Company intends that such
forward-looking statements be subject to the safe harbors created by the Reform
Act. These forward looking statements include (i) revenues to be recognized from
contracts with Ingram Micro, Tech Data Corporation and ATS Money Systems; (ii)
the Company's ability to fund its acquisition strategy; and (iii) the discussion
of the Company's efforts, and management's expectations, relating to Year 2000
compliance.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive and market conditions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. The forward-looking statements are dependent on a
number of factors, including (i) the economic and competitive environment of the
computer maintenance and information technology ("IT") support services industry
in general, and in the Company's specific market areas, (ii) its ability to
identify acquisition candidates, (iii) the Company's ability to successfully
integrate acquired operations with its existing operations, (iv) the Company's
ability to develop, produce, and market products and services that incorporate
new technology, are priced competitively, and achieve significant market
acceptance, (v) whether the Company's products and IT Services will be
commercially successful or technically advanced due to the rapid improvements in
computer technology and resulting product obsolescence, (vi) changes in the cost
of IT Services (vii) the Company's ability to deliver commercial quantities of
new products in a timely manner, (viii) the Company's ability to manage risks
associated with its operating strategies, (ix) changes in the Company's
operating strategy and capital expenditure plans, (x) the Company's ability to
manage its expenses commensurate to its revenues, and (xi) the Company's ability
to achieve Year 2000 compliance and the level of incremental costs associated
therewith, that could be adversely impacted by, among other things, the
availability and cost of programming and testing resources, vendors' ability to
modify proprietary software, and unanticipated problems identified in the
ongoing compliance review and (xii) other factors. In addition, the business and
operations of the Company are subject to substantial risks that increase the
uncertainty inherent in the forward-looking information included herein. The
inclusion of such information should not be regarded as a representation by the
Company, or any other person that the objectives or plans of the Company will be
achieved.
-10-
11
SUMMARY
The following table was derived from the Condensed Consolidated Statements of
Operations as a percentage of net sales for the three- and nine-month periods
ended November 22, 1998 and November 23, 1997:
RELATIONSHIP TO NET SALES
--------------------------------------------------------------
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
November 22, November 23, November 22, November 23,
1998 1997 1998 1997
------------ ------------ ------------ -----------
Net sales:
IT Service 86.8% 65.8% 82.0% 67.3%
Product 13.2 34.2 18.0 32.7
----- ----- ----- -----
Total net sales 100.0 100.0 100.0 100.0
Cost of sales 92.4 70.7 87.8 70.8
----- ----- ----- -----
Gross margin 7.6 29.3 12.2 29.2
----- ----- ----- -----
Selling, general and
administrative expense 40.1 37.0 34.4 41.3
Engineering, research and
development expense 4.1 7.0 5.0 7.7
Impairment of long-lived assets 26.8 -- 12.1 --
Interest (income) expense, net 0.3 (1.2) 0.2 (1.7)
Other (income) expense, net 4.2 (0.1) 1.8 0.2
----- ----- ----- -----
Loss before taxes (67.9) (13.4) (41.3) (18.3)
Provision for income taxes -- -- .1 0.1
===== ===== ===== =====
Net loss (67.9)% (13.4)% (41.4)% (18.4)%
===== ===== ===== =====
GENERAL
During the most recent quarter, the Company substantially expanded its
information technology ("IT") operations with the acquisition of Delta CompuTec
(DCI), which was financed by a bank term loan and the sale of redeemable
preferred stock and warrants. Additionally, the Company's IT Service organic
growth continued with the addition of a new distributor warranty service
agreement with Tech Data Corporation. Revenues from the Tech Data agreement, as
well as from agreements signed earlier this year with Ingram Micro and ATS Money
Systems, are expected to be realized in future operating periods. However, the
current period results of operations were negatively impacted as additional IT
Service costs of sales were incurred without significant related revenues. Also
during the current quarter, the Company resolved to focus on its core business
competencies within IT Services while pursuing strategic options surrounding its
AlphaCONNECT technology, including a strategic partnership, a spin-off from the
parent company, or the sale of the technology.
The Company had negative earnings before interest, taxes, depreciation and
amortization ("EBITDA") of $5,446,000, during the third quarter ended November
22, 1998, compared to a negative EBITDA of $266,000 during the same period of
the prior fiscal year. The Company had negative EBITDA of $6,595,000, for the
nine-month period ended November 22, 1998, compared to a negative EBITDA of
$1,610,000 during the same period of the prior fiscal year.
-11-
12
Significant to the comparative results of operations are charges totaling
$4,615,000 in the most recent quarter. These charges are comprised of the
following: (i) $2,230,000 to write-down impaired tangible and intangible assets
from non-core business acquired prior to 1998 to their estimated fair values
based on estimated cash flows, and write-down of accounts receivable related to
non-core operations, (ii) $910,000 to write-down impaired fixed assets and
inventory related to end-of-life proprietary product lines to their estimated
fair values, (iii) $749,000 related to software products obsolesced by the
introduction of new products, (iv) $379,000 resulting from the write-off of
notes receivable from previously sold assets and subsidiaries, (v) $256,000 of
indirect financing costs related to the sale of redeemable preferred stock and
warrants and the expensing of previously capitalized costs associated with
abandoned acquisitions, and (vi) $91,000 in write-offs of costs related to Year
2000 issues and adjustments of warranty and other liabilities. The table below
summarizes where these charges have been recognized on the statement of
operations for the periods ended November 22, 1998 (in thousands):
Cost of Operating Impairment
Sales Expenses Charge Other Total
------- --------- ---------- ----- -------
Impairment of tangible and
intangible assets $ 147 $ 495 $ 1,588 $ -- $ 2,230
Write-down of fixed assets and
inventory 60 -- 850 -- 910
Software obsolescence 666 83 -- -- 749
Loss on sale of assets and
subsidiaries -- -- -- 379 379
Indirect financing costs -- 256 -- -- 256
Year 2000 issues and operating
expenses 25 66 -- -- 91
----- ----- ------- ----- -------
Total $ 898 $ 900 $ 2,438 $ 379 $ 4,615
===== ===== ======= ===== =======
Also significant to the comparative results of operations is net interest
expense. During the three- and nine-month periods ended November 22, 1998, the
Company incurred net interest expense of $26,000 and $34,000 in each of the
periods, as compared to net interest income during the three and nine months
ended November 23, 1997 of $60,000 and $235,000, respectively. Accordingly, the
change in net interest expense during the most recent three- and nine-month
periods increased net loss by $86,000 and $269,000, respectively.
RESULTS OF OPERATIONS
Net Sales
Total net sales increased $5,950,000, or 41.7 percent, to $20,218,000 for the
nine-month period ended November 22, 1998 from $14,268,000 for the nine-month
period ended November 23, 1997. Net sales increased $3,965,000, or 77.5 percent,
to $9,083,000 for the three-month period ended November 22, 1998 from $5,118,000
for the three-month period ended November 23, 1997. The increase in total net
sales is due to increases in IT Service revenues, offset by declines in product
sales.
IT Services Sales
IT Service revenue increased $6,965,000, or 72.5 percent, to $16,574,000 during
the most recent nine-month period over the respective prior fiscal period, and
increased $4,513,000 or 133.9 percent, to $7,883,000 during the most recent
three-month period over the respective prior fiscal period. The nine- and
three-month revenue increases include $3,568,000 from the DCI acquired
operations and $2,202,000 and $654,000, respectively, attributable to non-core
businesses, not included in the prior periods. The balance of the revenue
increase during the nine- and three-month periods of $1,195,000 and $291,000,
respectively, is attributable to organic growth.
-12-
13
Product Sales
Total product revenues during the comparable nine-month periods declined
$1,015,000, or 21.8 percent, to approximately $3,644,000 from approximately
$4,659,000. Total product revenues during the comparable three-month periods
declined $548,000, or 31.4 percent, to approximately $1,200,000 from
approximately $1,748,000. While both domestic and European product sales
declined, a majority of the decline was due to the loss of sales to a large
European customer, which represented in the past a significant portion of the
Company's product revenues. No assurances can be made as to future product sales
levels whether domestic or international.
Gross Margin
Total gross margin for the Company for the first nine months of fiscal 1999
decreased to 12.2 percent compared to 29.2 percent during the same period last
year, and for the most recent three months of fiscal 1999 decreased to 7.6
percent compared to 29.3 percent during the same period last year.
IT Service Gross Margin
IT Services gross margin declined to 13.3 percent for the nine-month period
ended November 22, 1998, from 28.0 percent during the same period in the prior
year and declined to 15.1 percent for the three-month period ended November 22,
1998, from 27.1 percent during the same period in the prior year. The principal
factor contributing to the margin decline during the periods is the inclusion of
negative gross margins from non-core operations acquired prior to 1998 resulting
in approximately a 7.0 percent decrease during the nine-month period and a 5.0
percent decrease during the three-month period. Additionally, the gross margin
was negatively impacted during the nine- and three-month periods due to
increased depreciation related to other IT Service business acquisitions and
increased operating costs related to new IT Service contracts, for which no
significant service revenue was recognized. Due to the continuing shift from
proprietary to third-party IT Services, the Company does not expect gross
margins to return to historic levels.
Product Gross Margin
Product gross margin during the nine- and three-month periods declined to 6.8%
and (41.8)%, respectively, compared to 31.7% and 33.6% for the comparable prior
fiscal year periods. The decline is primarily due to a software obsolescence
charge of $666,000. The product margin decline is also due to both a reduction
in sales volume and increases in inventory reserves.
Selling, General and Administrative
Selling, general and administrative expenses increased $1,055,000 to $6,950,000
for the nine-month period ended November 22, 1998, compared to $5,895,000 for
the nine-month period ended November 23, 1997, and increased $1,743,000 to
$3,640,000 from $1,897,000 for the comparable three-month periods. The increase
in costs for both of these periods is primarily due to (i) additional general
and administrative costs and goodwill amortization associated with the DCI
acquisition; and (ii) increased accounts receivable reserves related to non-core
businesses. These increases were partially off-set by reduced spending related
to the AlphaCONNECT internet technology. The third quarter of the current year
also includes expenditures made in support of the Company's organic IT Service
growth plan and the development of the Company's new website.
Research and Development
Research and development expenses (which include engineering support and
services) incurred for the nine-month period ended November 22, 1998, decreased
by $90,000 to $1,011,000 from $1,101,000 during the same period in
-13-
14
the prior fiscal year. Research and development expenses as a percentage of
product sales increased to 27.7 percent for the nine months just ended from 23.6
percent during the comparable period in the prior fiscal year.
Other Expense
Other expense for the quarter and nine months ended November 22, 1998 includes
$379,000 of expense related to the write-down of notes receivable arising from
previously sold assets and subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended November 22, 1998, the Company's working capital
increased $413,000 from $4,333,000 at February 22, 1998 to $4,746,000. This
increase reflects $10,103,000 of net cash generated from financing activities,
offset by: $4,145,000 of cash used to acquired IT Service companies; $233,000 of
cash used for software capitalized, including the further development of the
Company's AlphaCONNECT technology; $1,428,000 of working capital to acquire
equipment, including the further implementation of the Company's new integrated
information system, and equipment purchases to support new service capabilities;
and the remaining decrease due primarily to cash used by operations of which
$1.2 million is attributable to an increase in accounts receivable.
The Company believes that its current cash position, augmented by future
operating activities, and working capital available through its Imperial Bank
revolving credit facility, will provide sufficient resources to finance its
working capital requirements through at least December 31, 1999. Advances under
the bank facility are subject to availability based on eligible accounts
receivable and certain financial covenants, including tangible net worth, debt
to tangible net worth and quick ratio minimum requirements. In order to fund its
acquisition strategy, the Company expects that additional capital will be
necessary. The Company's agreement with ING Equity Partners II, L.P. provides up
to an additional $5 million as an equity investment, subject to certain
conditions. The Company is also pursuing additional financing from other sources
to support its acquisition strategy, although there can be no assurances that
any financing will be available on acceptable terms. The Company's future
capital requirements depend on a variety of factors, including, but not limited
to, the rate of decline in the traditional proprietary business; the success,
timing, and amount of investment required to penetrate the Internet/intranet
markets; service revenue growth or decline; and potential acquisitions.
YEAR 2000 COMPLIANCE
Background
Most pre-1998 computers, software, and other equipment which utilizes
programming code contains calendar year data that is abbreviated to only two
digits. As a result of these design decisions, many of these systems could fail
to operate or fail to produce correct results if "00" is not interpreted to mean
2000. These problems may not be fully recognized, either as to frequency or
severity until the year 2000 arrives. These problems are commonly referred to as
the "Millennium Bug" or "Year 2000 Problem".
Assessment
The Year 2000 Problem affects certain of the computers, software, and other
equipment used, operated, or maintained by the Company. Accordingly, the Company
has undertaken a review of its internal computer programs and systems so that
its programs and systems will be Year 2000 compliant. The Company presently
believes that its
-14-
15
necessary and essential computer systems, software and equipment will be Year
2000 compliant in a timely manner. However, while the estimated cost of these
efforts are not expected to be material to the Company's financial position or
any year's results of operations, there can be no assurance to this effect.
Software Sold to Customers
The Company has been engaged for some time in the process of identifying and
resolving potential Year 2000 Problems with the software products which it has
developed and currently markets. However, management believes that it is not
possible to determine with complete certainty that all Year 2000 Problems
affecting the Company's software products will be identified or corrected due to
the complexity of these products and the fact that these products interact with
other third party vendor products and operate on computer systems which are not
under the Company's control.
Internal Infrastructure
The Company is engaged in reviewing its major computers, software applications,
and related equipment used in connection with its internal operations for Year
2000 Problems; however, the majority of the computer programs used by the
Company are off-the-shelf, recently developed programs from third-party vendors.
The Company is in the process of obtaining assurances from such vendors as to
the Year 2000 compliance of their products. Although some vendors make verbal
assurances of Year 2000 compliance, there can be no certainty that the systems
utilized by the Company will not be affected. The Company intends to continue
confirming with vendors, testing, replacing or enhancing its internal
applications to ensure that risks related to such software are minimized. This
process is expected to be completed in mid-1999.
Systems Other than Information Technology Systems
In addition to computers and related systems, the operation of office and
facilities equipment, such as fax machines, photocopiers, telephone switches,
security systems, elevators, and other common devices may be affected by the
Year 2000 Problem. The Company is currently assessing the potential effect of,
and costs of remediating, the Year 2000 Problem on its office and facilities
equipment. The Company estimates the total cost to the Company of completing any
required modifications, upgrades, or replacements of these internal systems will
not have a material adverse effect on the Company's business or results of
operations and anticipates that this process will be completed by mid-1999.
These estimates are being monitored and will be revised as additional
information becomes available.
Suppliers
The Company has initiated communications with third party suppliers of products
or services used, operated, or maintained by the Company to identify and, to the
extent possible, to resolve issues involving any Year 2000 Problems. However,
the Company has limited or no control over the actions of these third party
suppliers. Thus, while the Company expects that it will not be impacted by any
significant Year 2000 Problems experienced by its suppliers, there can be no
assurance that their suppliers will resolve any or all Year 2000 Problems with
these systems before the occurrence of a material disruption to the business of
the Company or any of its customers. Any failure of these third parties to
resolve Year 2000 problems with their systems in a timely manner could have a
material adverse effect on the Company's business, financial condition, and
results of operation.
Most Likely Consequences of Year 2000 Problems
The Company expects to identify and resolve the Year 2000 Problems that could
materially adversely affect its business operations. However, management
believes that it is not possible to determine with complete certainty that
-15-
16
all Year 2000 Problems affecting the Company have been or will be identified or
corrected. The number of devices that are affected and the interactions among
these devices are simply too numerous. In addition, accurate predictions of Year
2000 Problem-related failures will occur or the severity, duration, or financial
consequences of such failures cannot be made. As a result, management expects
that the Company could likely suffer the following consequences:
1. a number of operational inconveniences and inefficiencies for the Company
and its clients that may consume management's time and attention as well as
financial and human resources normally devoted to its ordinary business
activities; and
2. a lesser number of serious system failures that may require significant
efforts by the Company or its customers to prevent or alleviate material
business disruptions.
Costs
The Company has thus far performed the analysis described above using existing
personnel. The Company does not separately track internal costs incurred in
connection with analysis, investigation and implementation of Year 2000
compliance plans.
Contingency Plans
The Company is currently in the process of developing contingency plans to be
implemented as part of its efforts to identify and correct Year 2000 Problems
affecting its internal systems. The Company expects to complete its contingency
plans by the end of the second quarter of 1999. Depending on the systems
affected, these plans could include accelerated replacement of affected
equipment or software, short to medium-term use of backup equipment and
software, increased work hours for Company personnel or use of contract
personnel to correct on an accelerated schedule any Year 2000 Problems that
arise, development of manual workarounds for information systems, and similar
approaches. If the Company is required to implement any of these contingency
plans, it could have a material adverse effect on the Company's financial
condition and results of operations.
Based on the activities described above, the Company does not believe that the
Year 2000 Problem will have a material adverse effect on the Company's business
or results of operations.
-16-
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In December 1995, Phoenix Marketing, Inc. d.b.a. Electronic Business Systems,
Inc., in response to the Company's collection efforts for a past due account,
filed an amended cross-complaint alleging damages of $3,200,000 for defective
merchandise, loss of business reputation and loss of future business. The case
was consensually settled, with the settlement funded entirely by the Company's
insurance carrier.
Item 4. Submission of Matters to a Vote of Security-Holders
The Annual Meeting of Shareholders of Alpha Microsystems was held on October 15,
1998. At the Annual Meeting, all of management's nominees for directors listed
in the Proxy Statement were elected and there was no solicitation in opposition
to such nominees. Voting was as follows:
WITHHOLD
DIRECTORS FOR AUTHORITY ABSTAIN
--------- ---------- --------- -------
Clarke E. Reynolds 12,437,772 91,921 N/A
Douglas J. Tullio 12,432,672 97,021 N/A
Rockell N. Hankin 12,453,622 76,071 N/A
Carlos D. De Mottos 12,451,872 77,821 N/A
Benjamin P. Giess 12,450,272 79,421 N/A
Richard E. Mahmarian 12,450,722 78,971 N/A
The proposal to ratify the appointment of Ernst & Young LLP, as independent
auditors of the Company and its subsidiaries for the year ending February 28,
1999 was approved, receiving 12,428,210 votes for approval and 52,965 votes
against approval, with 48,518 abstentions. The proposal to approve the issuance
of certain warrants to purchase Common Stock which, upon exercise thereof, would
represent twenty percent (20%) or more of the outstanding shares of Common
Stock, together with the issuance of certain voting preferred stock granting the
holder thereof voting rights equivalent to the voting rights of the shares
issuable upon exercise of the warrants, which approval is necessary in order to
meet the continued listing requirements for the Common Stock on Nasdaq, was
approved, receiving 4,165,979 votes for approval, 347,460 votes against approval
and 96,409 abstentions. The proposal to amend the Articles of Incorporation to
increase the authorized number of shares of Common Stock was approved, receiving
12,019,682 votes for approval, 422,966 votes against approval and 87,045
abstentions. The proposal to approve the 1998 Stock Option and Award Plan was
approved, receiving 6,191,218 votes for approval, 499,026 votes against approval
and 101,052 abstentions.
-17-
18
Item 6. Exhibits and Reports on Form 8-K.
(a) See Exhibit Index.
(b) A Current Report on Form 8-K was filed by the Company on September 15,
1998 regarding the acquisition of Delta CompuTec Inc. and the funding of
an equity investment by ING Equity Partners II, L.P.
A Current Report on Form 8-K/A was filed by the Company on October 5,
1998 presenting the financial statements and pro forma financial
information applicable to the acquisition of Delta CompuTec Inc.
A Current Report on Form 8-K/A-2 was filed by the Company on October 6,
1998.
A Current Report on Form 8-K was filed by the Company on October 26,
1998 regarding a security sales transaction with ING Equity Partners II,
L.P.
A Current Report on Form 8-K was filed by the Company on December 29,
1998 regarding the adoption of a new fiscal year based on a calendar
year-end.
-18-
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALPHA MICROSYSTEMS
(Registrant)
Date: January 6, 1999 By: /s/ Douglas J. Tullio
-----------------------------
President and
Chief Executive Officer
Date: January 6, 1999 By: /s/ Jeffrey J. Dunnigan
-----------------------------
Vice President and
Chief Financial Officer
-19-
20
EXHIBIT INDEX
Number Description of Documents
- ------ ------------------------
3.5 Amendments to Restated Bylaws of Registrant dated August 3, 1998
3.6 Certificate of Amendment to Articles of Incorporation of Registrant dated
October 15, 1998
4.7 Warrant to Purchase Common Stock issued to Princeton Securities dated
October 20, 1998
10.69 Alpha Microsystems 1998 Stock Option and Award Plan
10.70 Form of Incentive Stock Option Agreement for use in connection with 1998
Stock Option and Award Plan
10.71 Form of Nonemployee Director Non-Qualified Stock Option Agreement to be
used in connection with 1998 Stock Option and Award Plan
10.72 Form of Nonemployee Director Non-Qualified Stock Option Agreement in Lieu
of Cash Compensation for Prior Services for use in connection with 1998
Stock Option and Award Plan
10.73 Form of Non-Qualified Stock Option Agreement for use in connection with
1998 Stock Option and Award Plan
10.74 Form of Non-Qualified Stock Option Agreement issued in connection with
the acquisition of Delta Computec, Inc.
10.75 Indemnification Agreement by and between Registrant and Carlos D. De
Mattos dated December 17, 1998
10.76 Indemnification Agreement by and between Registrant and John T. DeVito
dated December 17, 1998
10.77 Indemnification Agreement by and between Registrant and Benjamin P. Giess
dated December 17, 1998
10.78 Indemnification Agreement by and between Registrant and Sam Yau dated
December 17, 1998
27. Financial Data Schedule
-20-