1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT #1 TO FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 23, 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 Identification No.) incorporation or organization) 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 October 1, 1998, there were 11,066,321 shares of the registrant's Common Stock outstanding. 2 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SUMMARY The following table was derived from the Condensed Consolidated Statements of Operations as a percentage of net sales for the three and six month periods ended August 23, 1998 and August 24, 1997: RELATIONSHIP TO NET SALES ------------------------------------------------------- THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- ------------------------- AUGUST 23, AUGUST 24, AUGUST 23, AUGUST 24, 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Net sales: IT Service 81.3 % 69.0 % 78.1 % 68.0 % Product 18.7 31.0 21.9 32.0 ----- ----- ----- ----- Total net sales 100.0 100.0 100.0 100.0 Cost of sales 85.4 69.8 84.1 70.8 ----- ----- ----- ----- Gross margin 14.6 30.2 15.9 29.2 Selling, general and administrative expense 30.0 40.2 29.7 43.7 Engineering, research and development expense 5.8 8.3 5.7 8.1 Interest (income) expense, net 0.1 (1.7) 0.1 (1.9) Other (income) expense, net (0.2) 0.7 -- 0.3 ----- ----- ----- ----- Loss before taxes (21.1) (17.3) (19.6) (21.0) Net loss (21.1)% (17.3)% (19.7)% (21.1)% ===== ===== ===== ===== GENERAL During the most recent quarter, the Company focused on the completion of the Delta CompuTec (DCI) acquisition and the related sale of redeemable preferred stock and warrants, while continuing to pursue and invest in its long-term organic IT service growth strategies. This organic growth is demonstrated by a new IT service relationship with Ingram Micro and expansion of its relationship with ATS Money Systems to include TJ Maxx; revenues from both of these relationships are expected to be recognized beginning in September 1998. While these relationships are expected to be accretive to future results of operations, the second quarter results of operations were negatively impacted as additional IT service costs of sales were incurred without significant related revenues. Additionally, the Company continued its AlphaCONNECT development and marketing efforts. While revenues during the most recent quarter have not been significant, the Company recently introduced the AC Knowledge Management Suite and delivered a customized beta version of that product to Microsoft for use in its internal executive intranet. Costs related to the Company's internet business approximated $290,000 ($250,000 excluding capital expenditures) for the quarter ended August 23, 1998 and $550,000 ($450,000 excluding capital expenditures) for the six-months period then ended. Also significant to the comparative results of operations is net interest expense. During the three- and six-month periods ended August 23, 1998, the Company incurred net interest expense of $8,000 in each of the periods, as compared to net interest income during the three and six months ended August 24, 1997 of $79,000 and $177,000, respectively. Accordingly, the change in net interest expense during the most recent three- and six-month periods increased net loss by $87,000 and $185,000, respectively. 3 The Company had negative earnings before interest, taxes, depreciation and amortization ("EBITDA") of $676,000, during the second quarter ended August 23, 1998, compared to a negative EBITDA of $473,000 during the same period of the prior fiscal year. The Company had negative EBITDA of $1,149,000, for the six-month period ended August 23, 1998, compared to a negative EBITDA of $1,300,000 during the same period of the prior fiscal year. RESULTS OF OPERATIONS Net Sales Total net sales increased $1,986,000, or 21.7 percent, to $11,135,000 for the six-month period ended August 23, 1998 from $9,149,000 for the six-month period ended August 24, 1997. Net sales increased $1,089,000, or 23.7 percent, to $5,689,000 for the three-month period ended August 23, 1998 from $4,600,000 for the three-month period ended August 24, 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 $2,470,000, or 39.7 percent, to $8,691,000 during the most recent six-month period over the respective prior fiscal period, and increased $1,455,000 or 45.9 percent, to $4,627,000 during the most recent three-month period over the respective prior fiscal period. The six- and three-month increases include $1,547,000 and $791,000 attributable to ATI, respectively, not included in the prior periods. Product Sales Total product revenues during the comparable six-month periods declined $484,000, or 16.5 percent, to approximately $2,444,000 from approximately $2,928,000. Total product revenues during the comparable three-month periods declined $366,000, or 25.6 percent, to approximately $1,062,000 from approximately $1,428,000. 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 half of fiscal 1999 decreased to 15.9 percent compared to 29.2 percent during the same period last year, and for the most recent three months of fiscal 1999 decreased to 14.6 percent compared to 30.2 percent during the same period last year. While product gross margin did not change significantly, IT services gross margin declined to 11.7 percent for the six-month period ended August 23, 1998, from 28.4 percent during the same period in the prior year and declined to 13.1 percent for the three-month period ended August 23, 1998, from 29.5 percent during the same period in the prior year. The principal factor contributing to the margin decline during the periods include the negative gross margins from the acquired ATI operations of approximately 13 percent during the six-month period. The Company has reduced the operating expenses of the acquired ATI business in order for the business to generate a positive gross margin in future periods against projected revenues. Additionally, the gross margin was negatively impacted during the six- 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. Further, due to the continuing shift from proprietary to third-party IT services, the Company does not expect gross margins to remain at historic levels. Selling, general and administrative expenses decreased $688,000 to $3,310,000 for the six-month period ended 4 August 23, 1998, compared to $3,998,000 for the six-month period ended August 24, 1997, and decreased $140,000 to $1,709,000 from $1,849,000 for the comparable three-month periods. The decline in costs for both of these periods is primarily due to reduced spending related to the AlphaCONNECT internet technology. The second quarter of the current year includes discretionary 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 expenses (which include engineering support and services) incurred for the six-month period ended August 23, 1998, decreased by $108,000 to $636,000 from $744,000 during the same period in the prior fiscal year. Research and development expenses as a percentage of product sales increased to 26.0 percent for the six months just ended from 25.4 percent during the comparable period in the prior fiscal year. LIQUIDITY AND CAPITAL RESOURCES During the six months ended August 23, 1998, the Company's working capital decreased $3,003,000 to $1,330,000 from $4,333,000 at February 22, 1998. This decline includes anticipated working capital requirements as follows: $460,000 in direct acquisition costs; $221,000 of working capital for software capitalized, including the further development of the Company's AlphaCONNECT technology; $961,000 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 such as AS-400, Sun Microsystems and other products. 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 the end of fiscal year 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. Subject to shareholder approval on October 15, 1998, the Company has entered into an agreement with ING Equity Partners II, L.P. to provide up to an additional $12 million as an equity investment. 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 Some computers, software, and other equipment include programming code in which calendar year data is abbreviated to only two digits. As a result of this design decision, some of these systems could fail to operate or fail to produce correct results if "00" is interpreted to mean 1900, rather than 2000. These problems are widely expected to increase in frequency and severity as the year 2000 approaches, and are commonly referred to as the "Millennium Bug" or "Year 2000 Problem". Assessment The Year 2000 Problem could affect computers, software, and other equipment used, operated, or maintained by the Company. Accordingly, the Company is reviewing its internal computer programs and systems to ensure that the 5 programs and systems will be Year 2000 compliant. The Company presently believes that its computer systems 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 Consumers The Company is in the process of identifying and resolving all potential Year 2000 Problems with any of the software products which it develops and 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 believes that its major computers, software applications, and related equipment used in connection with its internal operations are not subject to significant Year 2000 problems, because 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. This estimate is being monitored and will be revised as additional information becomes available. Suppliers The Company has initiated communications with third party suppliers of the major computers, software, and other equipment used, operated, or maintained by the Company to identify and, to the extent possible, to resolve issues involving the Year 2000 Problem. However, the Company has limited or no control over the actions of these third party suppliers. Thus, while the Company expects that it will be able to resolve any significant Year 2000 Problems with these systems, there can be no assurance that these 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 all 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 all Year 2000 Problems affecting the Company have been identified or corrected. The number of devices that could be affected and the interactions among these devices are simply too numerous. In addition, one cannot accurately 6 predict how many Year 2000 Problem-related failures will occur or the severity, duration, or financial consequences of these perhaps inevitable failures. As a result, management expects that the Company could likely suffer the following consequences: 1. a significant number of operational inconveniences and inefficiencies for the Company and its clients that may divert management's time and attention and financial and human resources from 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. Contingency Plans The Company is currently 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 or to provide 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. 7 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: February 11, 1999 By: /s/ Douglas J. Tullio ---------------------- President and Chief Executive Officer Date: February 11, 1999 By: /s/ Jeffrey J. Dunnigan ------------------------ Vice President and Chief Financial Officer