- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- Form 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(k) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 ---------------- Commission file number: 0-20215 MICROTOUCH SYSTEMS, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-2802971 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 300 Griffin Brook Park Drive Methuen, MA 01844 (Address of principal executive offices) (Zip Code) (978) 659-9000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, $0.01 par value 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 [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock held by nonaffiliates of the registrant as of February 11, 2000, was approximately $82,599,000 (based on the last price of such stock as reported by NASDAQ Stock Market on such date). The number of shares outstanding of each of the registrant's classes of capital stock, as of February 11, 2000 was: Common Stock, $0.01 par value 6,527,684 Portions of the Registrant's proxy statement for the Annual Meeting of Stockholders to be held June 22, 2000 are incorporated by reference into Part III of this Form 10-K. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Item 1. Business General MicroTouch Systems, Inc (the "Company" or "MicroTouch") is a leading supplier of touch and pen sensitive input systems including touchscreens and electronic whiteboards. The Company's principal products are its touch sensitive screens, which are based on the Company's two primary technologies-- analog capacitive sensing (referred to as ClearTek(R)) and resistive membrane (known as TouchTek(TM)). In both the capacitive and resistive membrane cases, the screens are configured to CRT monitors and flat panel displays. The Company believes its touchscreens are well suited for a wide variety of markets and applications where ease of use, speed, accuracy and durability are desirable. Over the last decade, the use of personal computers has grown in a wide range of applications. As a result, demand has increased for products that make these systems more accessible to a broader range of users. For example, the development of graphical user interfaces ("GUIs"), such as Microsoft Windows, has allowed information to be displayed in an easy to understand graphic manner. Touch products address this demand by allowing both trained and untrained computer users to interact with computers in a natural and intuitive manner. Touchscreens allow individuals to access information and interact with a computer simply by touching the computer's screen with a finger. Because pointing is a natural instinct, touchscreens offer a highly intuitive computer interface. Touchscreens are designed to allow users to interact with their system without the use of a keyboard, mouse or trackball. Accordingly, the ease of use offered by touchscreen-based systems makes them well suited both for applications for the general public and for specialized applications for trained computer users. The Company has expanded its product line primarily through internal development as well as acquisitions in the past. Technologies acquired through acquisition include ThruGlass and resistive membrane technology. Over the past four years, the Company has developed and marketed a new product referred to as an electronic P.C. whiteboard. This new product, marketed under the trademark of Ibid(TM), allows the user to write or draw information on a whiteboard and then to electronically view and transfer the written information to a desktop or notebook P.C. The discussion contained in this section and elsewhere in this Annual Report on Form 10-K may contain forward-looking statements based on the current expectations of the Company's management. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. 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 result of any revisions to these forward-looking statements, which may be made to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. Strategy MicroTouch's objective is to be the leading worldwide supplier of touch products and to exploit opportunities in other touch and related markets through the development and acquisition of complementary technologies and product lines. The key elements of the Company's strategies are as follows: Focus on Vertical Markets. The Company's strategy for its touch products is to focus on vertical markets in which the Company believes touch technology offers significant benefits and appeals to a broad customer base. The Company's sales force is organized into geographic territories that focus on customers within these distinct vertical markets. In addition, specialized experts exist within the sales force for several of the vertical markets including point-of-sale cash registers, interactive kiosks, medical applications, mobile information devices and gaming and entertainment equipment. Target Developers of End User Applications. The Company directs its sales efforts for its touch products toward original equipment manufacturers (OEMs), value added resellers (VARs), system integrators and high- 2 volume end users, which the Company believes are best able to develop and market applications for the Company's targeted vertical markets. The Company seeks to have its products designed into the end user systems or products of these customers. Provide Flexible Product Offerings. The Company works closely with its customers to understand their businesses and product requirements. The Company offers its ClearTek and TouchTek touchscreens, and TouchPen sensors in a variety of standard and customized configurations to meet the diverse needs of the markets which it serves. The ThruGlass products which allow for gloved touch operation of a computer through up to an inch of glass, can also be customized to meet the requirements of emerging end-user applications. Enhance and Expand Technology. The Company's traditional technology is its proprietary analog capacitive sensing technology. MicroTouch seeks to improve its products by enhancing this technology through the development of new glass coating techniques, custom ASICs, controllers, software algorithms and software drivers. The Company also seeks to develop new technologies through internal development, licensing or acquisitions. The Company has developed TouchPen, a touch and stylus sensitive device used for pen-based applications. The Company also markets ThruGlass, which allows touch to be sensed through other conductive media. During the past two years, the Company has significantly enhanced its resistive membrane technology through product development programs similar to those undertaken for the capacitive product line. Finally, the electronic whiteboard product was developed based on resistive technology obtained in the 1995 Touch Technology acquisition, a business engaged in the development and marketing of touch sensitive screens primarily using resistive membrane technology. Pursue New Market Opportunities. The Company is currently applying its existing technologies to new market opportunities where it believes these technologies can have significant growth potential. These opportunities include consumer devices for resistive technology and, with respect to TouchPen applications, use for pen computing, videoconferencing and image manipulation in interactive kiosks. Expand International Markets. The Company has increased its international presence through the opening of foreign sales offices and manufacturing facilities. The Company currently has touchscreen sales and manufacturing facilities in the United Kingdom and Australia and sales offices in France, Germany, Italy, Spain, Japan, Taiwan, Korea and Hong Kong. The Company's international sales, including U.S export sales, increased from $57.4 million in 1997 to $71.4 million in 1998 and to $76.0 million in 1999. Technology Analog Capacitive Technology. The Company's primary touchscreen technology is its proprietary analog capacitive sensing technology. This technology creates a uniform voltage field on the conductive surface of the touch sensor. When a finger comes into capacitive contact with the conductive layer, it draws a small amount of current to the point of contact. A controller attached to the conductive surface determines the point of contact by measuring the relative current flows from the four corners of the surface. The Company implements this technology on a glass panel that has a transparent conductive coating fused to its surface. In most of the Company's products, a proprietary glass overcoat is then laid over the conductive coating for additional protection. The conductive glass panel, or sensor, is driven at its four corners by an A/C sine wave voltage which is dispersed linearly over the sensor by an electrode pattern located on the perimeter of the sensor. When a user touches the screen, the controller determines the point of contact and transmits the location to the computer for processing. The Company's analog capacitive sensing technology has many favorable attributes, including: High Touch Sensitivity. Because the Company's touchscreens rely on capacitive contact rather than activation by pressure, they offer a high degree of sensitivity to input from a finger. This is important in applications characterized by continuous usage such as cash registers, where a requirement to exert pressure on the screen might be uncomfortable over time and slow down input and, therefore, customer service. 3 Fast Touch Speed. The Company's proprietary software algorithms enable the controller to detect quickly a touch on the screen. This capability can enable operators of products such as touch-based cash registers to input numbers as quickly as they could using buttons or keypads. High Resolution. The Company's touchscreens have a resolution of at least 1,024 by 1,024 points. Because the controller averages the entire area of finger contact and reports a single point, even a finger is able to obtain pixel-level control of the cursor on a display. This resolution allows for the creation of detailed menus and greater flexibility in screen design. Resistant Properties. The capacitive nature of the Company's touchscreens allows them to function unimpaired even when contaminants such as water, dirt or grease build up on the surface. This is an important feature in factory environments, public locations and restaurants. Durability. With its proprietary glass overcoat, the Company's capacitive touchscreens are scratch, wear and chemical resistant. In addition, the glass sensor may be optically bonded to the computer screen in a process designed to give structural support to the screen. Durability is an important feature in applications such as entertainment and point of sale, which are characterized by frequent use. Ease of Integration. The Company's glass sensors are easily fabricated into a variety of shapes and sizes and are readily installed in displays in a manner that results in a professional looking fit and finish. Resistive Membrane Technology. The Company's TouchTek "resistive membrane" technology has several attributes that are similar to those of its capacitive systems. TouchTek screens work by creating a uniform voltage field on a glass substrate. When a plastic top sheet is compressed into contact with the glass layer, current is drawn from each side of the glass layer in proportion to the distance from the edge. An electronic controller calculates the position of the finger based on the current flows. Some of the Company's resistive products fall into a category known as 5-wire resistive and the Company has recently placed more emphasis on offering 4-wire resistive products for certain specialty consumer device applications as customer requirements dictate. ThruGlass Technology. MicroTouch's ThruGlass technology operates by projecting voltage fields out from the conductive surfaces of transparent glass connected to a controller. When an individual touches the surface in front of the projected capacitive touchscreen, minute changes in the voltage field are detected and the touch is assigned to a location on the sensor. TouchPen Technology. TouchPen utilizes a modified form of the Company's analog capacitive technology to sense both a finger and a pen touch. TouchPen's controller is able to electrically distinguish the hand from the pen signal, allowing it to reject the hand signal when writing. The touch performance of TouchPen is equal to the Company's analog capacitive ClearTek product, while the pen offers even higher resolution of 2,048 by 2,048 to capture handwriting. There are several alternative touch technologies currently in use by other manufacturers. These technologies include (i) resistive membrane products similar to the Company's; (ii) scanning infrared, which uses a grid of infrared beams; (iii) surface acoustic wave or "SAW" screens, which are based on the transmission of acoustic waves across a glass overlay; (iv) guided acoustic wave or "GAW" screens, which are based on the transmission of acoustic waves through a glass surface; and (v) piezo technology, in which piezo, or pressure, sensors convert touch forces into electrical signals. Products Markets, Applications and Customers The Company sells its products into a variety of markets, including self- service kiosks, point of information displays, point of sale equipment, gaming and entertainment systems, industrial and medical systems and training and business systems. Specific customer applications include; airline and movie theatre ticketing, exhibits and trade shows, tourist information centers, museum exhibit guides, restaurant and merchandise cash registers, 4 customer self service, casino video gaming machines, bartop entertainment gaming, children's entertainment kiosks, process control, video banking and ATM's, financial trading and portable information devices. Touchscreens The Company's principal product line over the last several years has been the ClearTek 2000 Touch Screen. The Company recently introduced its next generation capacitive product, the ClearTek 3000 Touch Screen, in a variety of configurations, including kits comprised of touch sensors and controllers or chipsets, and fully configured touchscreen monitors. In addition, the Company customizes its products to accommodate particular customer needs. The new ClearTek 3000 Touch Screen system has a resolution of 1,024 by 1,024 points and interprets the entire area of touch contact as a single point, giving a finger the ability to select targets as small as a single pixel. The screen detects a touch in as little as 8-12 milliseconds making it fast in operations such as hitting buttons on a touchscreen-based cash register. The TouchTek resistive touchscreen systems utilize a conductively coated plastic top sheet over a conductively coated and rigid bottom sheet, usually glass. Resistive kits are configured similarly to capacitive kits. The principal elements of both the ClearTek 3000 and the TouchTek product lines include the following: Sensors. The Company's glass sensors, which are installed on the face of computer screens, are offered in a large number of curved and flat screen sizes, as well as in custom sizes. Screens may be optically bonded to monitors through a process developed by the Company to fill the space between the touchscreen and the monitor with a transparent bonding compound. Optically bonded sensors increase optical clarity and provide greater structural support. The Company's ClearTek sensors are overcoated with the Company's exclusive glass top-coating for added durability and optical clarity. Controllers. Controllers offered by the Company have USB, serial, PC bus, ADB or TTL interfaces and will operate with any of the Company's touchscreens. Capacitive chipsets, which include a proprietary ASIC, are sold to larger volume OEMs for incorporation into the electronics of their systems. Software Drivers and Tools. GUI drivers and software tools provided by the Company include an MS-DOS mouse emulator; Windows, OS/2, Macintosh, Windows NT, Amiga, and various UNIX drivers; and an MS-DOS software tool for creating and defining touch zones. Options. The Company sells a variety of options and accessories, including power supplies, cables and privacy shields, and also offers retrofitting and optical bonding services. Touch Enabled Monitors The Company also sells several lines of fully integrated standard monitors which range in size from 13 to 27 inches and support popular graphics standards. These monitors are typically purchased from display manufacturers and equipped by the Company with an optically bonded sensor and a controller. The Company also provides independent integration services for monitor customers primarily through third party suppliers. Electronic Whiteboard The Company markets a line of electronic PC whiteboards including both personal (2 foot by 3 foot) boards as well as larger (3 foot by 4 foot and 4 foot by 6 foot) conference room boards The Company's electronic whiteboard product is a variation of the resistive membrane technology used in the TouchTek line. Sales and Marketing MicroTouch markets and sells its touch products primarily through VARs, OEMs and systems integrators, and to high volume end-users. The Company employs a direct sales force for domestic sales and certain 5 international regions, and supports its marketing efforts with trade show attendance, telemarketing, advertising and public relations. As of December 31, 1999, the Company's sales and support function consisted of 118 persons. The sales force is organized into several geographic sales groups, each focusing on a separate set of regional customers, and is augmented by several vertical market specialists. The Company markets its touch products in Europe through its U.K. subsidiary, MicroTouch Systems, Ltd. MicroTouch Systems, Ltd. sells through various European distributors and sells direct in the U.K., Germany, France, Spain and Italy. This subsidiary also assembles touch monitors from touchscreen kits exported from the U.S. and monitors purchased in Europe. During 1998, the Company established a direct sales office in Spain. In Japan, the Company sells its products through MicroTouch Systems, KK. In 1994 MicroTouch established a direct sales and manufacturing presence to serve the Australian and New Zealand touchscreen markets providing a base from which to continue sales of MicroTouch products primarily to the Australian gaming market. The Company opened a sales office in Taiwan in 1995, in Korea and Hong Kong in 1997, and in Singapore in 1999. The Company's total international sales, including U.S. export sales, accounted for approximately 45%, 49% and 48% of total sales in 1997, 1998 and 1999, respectively. The Company plans to continue to increase its sales presence, both domestically and overseas, in an effort to broaden its potential customer base and to intensify its efforts in its targeted markets. As part of this plan, the Company intends to increase its worldwide sales force and add additional distributors and agents. The Company offers a 30-day money back guaranty on its touchscreen products to first-time buyers. This offer pertains only to the first unit purchased and is void if the unit is altered by the customer in any way. Additionally, the Company generally replaces products not meeting its specifications that are returned by any customer within 30 days of receipt. The Company provides reserves for estimated returns and believes that such reserves are adequate. The amount of product returns was approximately $4.5 million, $4.9 million and $5.6 million for the years ended December 31, 1997, 1998 and 1999, respectively. While the Company believes that its reserves for product returns are adequate, there can be no assurance that the Company will not experience increased product returns. Any such increase in product return claims could have a material adverse effect on the Company's results of operations. The Company's customers generally provide direct support to end users for the Company's products while MicroTouch, in turn, supports its resellers with application engineers and phone support from its customer service group of trained technicians. The Company typically offers its customers a product warranty of up to five years. While the Company believes that its reserves for warranty claims are adequate, there can be no assurance that the Company will not experience increased warranty claims. Any such increase in warranty claims could have a material adverse effect on the Company's results of operations. Research and Development The Company's future success depends in large part upon the timely enhancement of existing products and the continued development of new products to address new market opportunities. Accordingly, the Company intends to continue to devote significant resources to increasing the performance of its existing products, especially its capacitive and resistive technologies, developing new products from its existing technologies and developing new technologies. The Company has, in the past, augmented and may continue to augment its research and development efforts through the acquisition or licensing of new technologies. The Company's research and development efforts in the touchscreen area are primarily focused on expanding the range of configurations offered, enhancing product features, expanding the capability of drivers to interact with different types of computer operating systems and refining existing products to increase manufacturing efficiency and reduce costs. The Company's development efforts are also directed toward improving the product features and enhancing the underlying technology of its various product lines. There can be no assurance that the Company 6 will successfully complete such development efforts or that these product developments will achieve market acceptance. As of December 31, 1999, 83 full-time employees of the Company were engaged in research and development activities. In addition, the Company frequently engages independent consultants to supplement its own research and development efforts and to gain access to expertise in specific technical areas. Proprietary Rights and Licenses The Company relies on a combination of patents, trade secrets and know-how to establish and protect its proprietary rights. The Company acquired exclusive rights to its core analog capacitive technology under a worldwide license from Peptek, Inc. and its affiliate, Mr. Jim Zeeger (the "Peptek License"). Under the Peptek License, the Company has the exclusive right to use all technology covered by the patent claims in the manufacture and sale of the Company's touchscreen and similar products. The patents licensed under the Peptek License include claims of rights to the configuration of the electrodes installed around the perimeter of the glass sensor of a touchscreen and in the method used to determine the point of finger contact on the surface of the glass sensor. The Peptek License requires the Company to pay royalties based on annual product sales and sublicensing revenues and includes minimum royalty payment provisions. The Peptek License may be terminated by the licensor only in the event of a breach of the license agreement by the Company, which is not remedied within applicable cure periods and in the event of the Company's bankruptcy. MicroTouch holds exclusive rights to the patents covering its core proprietary technology until the respective expiration dates of such patents, which currently range from 2000 to 2015. The Company also owns certain other patents and patent applications, related primarily to improvements on, and extensions of, its core technology, as well as certain software algorithms used with the Company's products. The Company holds two patents, one of which will expire in the Year 2000, which cover the configuration of the electrodes installed around the perimeter of the glass sensor used in the Company's analog capacitive products. Several other patents related to the Company's core analog capacitive technology will expire during 2000. Although the Company has developed considerable know-how and has substantial experience in the field of analog capacitive technology, which it believes will enable the Company to compete effectively in the future, the expiration of patents covering the Company's core proprietary technology during the next several years may lead to the development by third parties of products that are competitive with those of the Company. The successful development and marketing by third parties of competitive products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company acquired exclusive rights to use its ThruGlass proprietary technology in the touchscreen field, including rights under pending patent applications, under a worldwide license from Moonstone Designs, Ltd. (the "Moonstone License"). Under the Moonstone License, the Company has the exclusive right to use all technology covered by the claims of any patent that may issue in the manufacture and sale of the Company's projected capacitive products. There can be no assurance that such patents will issue or that the claims under such patents may not be reduced from the claims in the patent applications. The Company acquired exclusive rights to use certain force based proprietary technology in the touchscreen field, including rights under three patents, under a worldwide license. The Company has the exclusive right to use all technology covered by the claims of the patents in the manufacture and sale of the Company's products. Other rights held by the Company include nonexclusive rights to use its resistive technology, including rights under several patents acquired in 1995. In addition, two patents have been granted and applications for two additional U.S. patents on various technology related to whiteboard products have been submitted. The Company was also granted three patents covering software for Internet public access computers and kiosks during 1998. 7 The Company typically requires persons such as customers, licensees and employees who have access to proprietary information concerning the Company's products to sign nondisclosure agreements that prohibit the use of the Company's proprietary information other than for the specific purpose for which it was provided. Other companies are engaged in the development of technologies that may result in products competitive with those made by the Company. These development efforts may result in proprietary technology, and possibly patents, that could impair the value of, or render obsolete, technology owned or licensed by the Company. Furthermore, there can be no assurance that any patent owned or licensed by the Company will withstand challenges or otherwise provide the Company with adequate protection from competitors, or that the Company will be able to afford the expense of enforcing these patents. Manufacturing MicroTouch's touchscreen manufacturing operations consist primarily of the procurement of glass (coated and fabricated to its specifications) and the manufacture of touch sensors from that glass, the procurement and testing of electronic components specified or designed by MicroTouch, and, in some cases, the integration, including optical bonding, of touchscreen monitors. The majority of the manufacturing activities for both capacitive and resistive touchscreens are performed at the Company's principal facility in Methuen, Massachusetts. The Company also exports touchscreen kits to its foreign operations for final integration with monitors for distribution in Europe, Japan, the Pacific Rim and Australia. In addition, certain resistive products are manufactured in Austin, Texas on a special project basis. Although the Company generally uses standard parts for its products, certain components, such as ASICs and the coated glass used in the production of touch sensors are currently available only from a single source. In the event that suppliers are unable to fulfill the Company's requirements, the resulting interruption in production would have an adverse impact on the Company's operating results. While the Company maintains some inventory of ASICs, coated glass and other components, the inventory amounts maintained are not sufficient to eliminate the potential impact of prolonged supply interruptions. While the Company believes that there are other companies that are capable of manufacturing these sole source components, the inability to obtain sufficient components as required, or to develop alternative sources if and when needed, would adversely affect the Company's operating results. Competition The markets for touch products are highly competitive and subject to rapid technological change. The Company believes that the principal competitive factors in its markets are product characteristics such as touch performance, durability, optical clarity and price, as well as supplier characteristics such as quality, service, delivery time and reputation. The Company believes that it competes favorably with respect to these factors, although there can be no assurance that the Company will be able to continue to compete successfully in the future. The Company faces competition from several established touch product vendors as well as a number of smaller companies. Some of these competitors utilize analog capacitive sensing and resistive membrane technologies similar to the Company's technologies. Two of the Company's principal touchscreen competitors, Elo Touch Systems, Inc., and Carroll Touch Technology, both subsidiaries of Tyco International Ltd., are operations of that larger, diversified industrial company which has greater financial, technical, manufacturing and marketing resources than the Company. Elo Touch Systems markets touchscreens based primarily on resistive and surface acoustic wave technology, and Carroll Touch Technology markets touchscreens based primarily on infrared and guided acoustic wave technology. In addition, several manufacturers, most notably IBM, have developed proprietary touchscreen products in the past but are not currently marketing proprietary products. There are several private companies which have marketed resistive touchscreens for years and who are, therefore, more established in that market segment than the Company. In the market for pen-based computers, the Company's TouchPen product competes with digitizers marketed by several companies and could compete with 8 products that may be developed in the future by manufacturers that have more significant resources than the Company. Products similar to ThruGlass are marketed by at least one competitor to the Company, especially in the European market. Several other companies market electronic whiteboard products similar to those of the Company. Backlog The Company maintains most standard products in inventory and manufactures other standard, modified standard and custom products pursuant to orders from customers. Backlog consists of orders for products, which have a scheduled shipment date within twelve months of the order. Because a large percentage of the Company's orders require products to be shipped in the same quarter in which the order was received, and because orders in the backlog may be canceled and delivery schedules may be changed, the Company's backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. As of December 31, 1998 and 1999, the Company had a backlog of $23.3 million and $21.4 million, respectively. Employees As of December 31, 1999, the Company had 845 full-time employees, of which 536 were engaged in manufacturing, 142 were in sales, marketing and customer service and 83 were in research and development. The Company considers its relations with its employees to be good. Item 2. Properties The Company leases approximately 96,000 square feet of office, engineering and manufacturing space located at 300 Griffin Park, Methuen, Massachusetts. The lease covering these properties expires in April 2003. The Company also leases an aggregate of approximately 97,000 square feet of additional space at its other locations including those in the U.K., France, Germany, Italy, Japan, Australia, Spain, Hong Kong, Korea, Taiwan and Austin, Texas. In addition, the Company is leasing approximately 88,000 square feet in Rochester, New York, the lease for which expires in November, 2002. Approximately 35,000 square feet of this space is currently sublet and the Company is attempting to sublease the remaining space. During 1998 the Company expanded the building it owns, which is adjacent to the Methuen, Massachusetts corporate headquarters. This facility now has 70,000 square feet of space and houses the Company's information technology function, administrative staff and additional touchscreen and whiteboard manufacturing space. In 1999, the Company leased 44,000 square feet of warehouse space in Lawrence, Mass. Item 3. Legal Proceedings The Company had been involved in an international arbitration entitled MicroTouch Systems, Inc. v. Nissha Printing Co. Ltd. ("Nissha"), which was under the auspices of the International Chamber of Commerce ("ICC"). The case was based on the Company's claims that Nissha breached non competition provisions and other terms of a distribution agreement between the Company and Nissha. In January 1997, the Company was informed that while it had won the case based on the merits of its claims, any recovery of damages was time barred under the terms of the original agreement between the two parties in the dispute. As a result, the Company was required to pay a portion ($595,000) of Nissha's fees and costs associated with the arbitration. The Company expensed these fees and costs awarded to Nissha as part of its second quarter 1997 financial results, thus completing the Company's involvement in the matter. During the period from mid 1995 to early 1997, the Company was involved in a case entitled Elo Touch Systems, Inc. v. The Graphics Technology Company, Inc., MicroTouch Systems, Inc. et al, which was in the United States District Court in Knoxville, Tennessee. The case arose from claims by Elo Touch Systems ("Elo") that The Graphics Technology Company, Inc. (the predecessor to the Company's Touch Technology business) 9 manufactured and sold, and that the Company intended to manufacture and sell in the future, certain products which infringe certain patent rights held by Elo. This case was settled by a cross-licensing agreement reached among the parties during 1997. The Company was a plaintiff in a case entitled MicroTouch Systems, Inc. and Peptek, Inc. v. Elo Touch Systems, Inc. which was in the United States District Court in Knoxville, Tennessee. The case arose from claims by the Company and Peptek, Inc. ("Peptek") that Elo manufactured and sold products that infringed certain patent rights held by Peptek and exclusively licensed to the Company. This case was settled by a cross-licensing agreement reached among the parties during 1997. The Company has been a defendant in a case entitled Behne v. MicroTouch Systems, Inc., in the United States District Court in the Northern District of California. The case arose from claims by Ms. Behne, a former employee of MicroTouch, regarding gender discrimination, retaliation and misrepresentation during her employment at the Company. In March, 1999 a jury found the Company not liable on the discrimination and retaliation claims, but awarded the plaintiff approximately $2,600,000 in compensatory and punitive damages under the misrepresentation claim. While the matter continues under the appeals process, the Company has established a reserve for the full amount of the initial jury judgement, as well as associated legal fees, in the amount of $3,303,000, of which approximately $2,900,000 remained in the reserve at December 31, 1999. In addition to the matters described above, the Company is subject to various investigations, claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be resolved unfavorably to the Company. The Company has established accruals for loss contingencies that are probable and reasonably estimable. Management believes that any liability that may ultimately result from the resolution of these matters in excess of amounts provided will not have a material adverse effect on the financial position or results of operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders The Company submitted no matters to a vote of its shareholders during the fourth quarter of 1999. 10 PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters The Company's common stock is quoted on the Nasdaq Stock Market under the symbol "MTSI." The following table sets forth the range of high and low sales prices per share. High Low ------ ------ 1999 First Quarter............................................. $19.56 $11.88 Second Quarter............................................ $15.56 $12.25 Third Quarter............................................. $17.50 $14.56 Fourth Quarter............................................ $17.94 $12.06 1998 First Quarter............................................. $19.63 $13.38 Second Quarter............................................ $20.94 $14.50 Third Quarter............................................. $18.63 $10.88 Fourth Quarter............................................ $16.88 $12.25 The Company has never paid a cash dividend on its common stock and currently expects that future earnings will be retained for use in its business. As of February 11, 2000, the Company had 245 stockholders of record and approximately 4,000 beneficial stockholders. 11 Item 6. Selected Consolidated Financial Data The selected consolidated financial data presented below for each of the five years in the period ended December 31, 1999 have been derived from the Company's consolidated financial statements. The consolidated financial statements for each of the five years in the period ended December 31, 1999 have been audited by Arthur Andersen LLP, independent public accountants. This data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and other financial information appearing elsewhere in this document. Years Ended December 31, ------------------------------------------ 1995 1996 1997 1998 1999 ------- ------- -------- -------- -------- (in thousands, except per share amounts) Statement of Operations Data: Net sales.......................... $76,718 $95,045 $128,481 $144,370 $157,491 Cost of sales...................... 47,735 58,995 83,553 88,950 104,323 ------- ------- -------- -------- -------- Gross profit................... 28,983 36,050 44,928 55,420 53,168 Operating expenses: Research and development......... 5,027 7,225 7,985 10,904 12,816 Sales and marketing.............. 11,607 13,568 18,765 21,235 20,862 General and administrative....... 5,314 6,360 7,944 10,012 11,225 Amortization of intangible assets and purchased technology........ 381 460 477 502 333 Write-off of purchased technology and related assets.............. 1,985 -- -- -- -- Purchased in-process research and development and related costs... 3,000 -- -- -- -- Non-recurring charge............. -- -- -- -- 1,950 ------- ------- -------- -------- -------- Total operating expenses....... 27,314 27,613 35,171 42,653 47,186 ------- ------- -------- -------- -------- Operating income................... 1,669 8,437 9,757 12,767 5,982 Other income, net.................. 2,014 1,464 579 1,009 1,249 Arbitration/litigation costs....... 1,019 954 595 -- 3,303 ------- ------- -------- -------- -------- Income before provision for income taxes............................. 2,664 8,947 9,741 13,776 3,928 Provision for income taxes......... 980 3,250 3,330 4,408 1,257 ------- ------- -------- -------- -------- Net income......................... $ 1,684 $ 5,697 $ 6,411 $ 9,368 $ 2,671 ======= ======= ======== ======== ======== Earnings per share: Basic............................ $ 0.21 $ 0.74 $ 0.81 $ 1.22 $ 0.39 Diluted.......................... $ 0.20 $ 0.71 $ 0.77 $ 1.20 $ 0.38 Weighted average common shares outstanding and dilutive potential common shares outstanding Basic............................ 8,114 7,695 7,941 7,672 6,914 Diluted.......................... 8,607 8,066 8,349 7,815 7,065 December 31, ------------------------------------------ 1995 1996 1997 1998 1999 ------- ------- -------- -------- -------- (in thousands) Balance Sheet Data: Working capital.................... $55,748 $58,372 $ 63,265 $ 59,060 $ 46,801 Total assets....................... 76,353 85,048 94,837 104,345 97,104 Stockholders' equity............... 63,851 69,170 78,948 78,369 69,508 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The discussion contained in this section as well as elsewhere in this Annual Report on Form 10-K may contain forward-looking statements based on the current expectations of the Company's management. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. 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 result of any revisions to these forward-looking statements which may be made to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. The following table sets forth for the fiscal periods indicated, the percentage of total revenues represented by certain items in MicroTouch's statement of operations: Percentage of Total Revenues Year Ended December 31, ------------------------- 1997 1998 1999 ------- ------- ------- Total Revenues...................................... 100.0% 100.0% 100.0% Cost of Sales....................................... 65.0 61.6 66.2 Gross Profit...................................... 35.0 38.4 33.8 Operating Expenses: Research and Development.......................... 6.2 7.6 8.1 Sales and Marketing............................... 14.6 14.7 13.3 General and Administrative........................ 6.2 6.9 7.1 Amortization of Intangible Assets and Purchased Technology....................................... 0.4 0.4 0.2 Non-recurring Charge.............................. 0.0 0.0 1.2 Total Operating Expenses........................ 27.4 29.6 29.9 Operating Income.................................... 7.6 8.8 3.9 Other Income, net................................... 0.5 0.7 0.8 Arbitration Litigation Costs........................ 0.5 0.0 2.1 Income Before Provision for Income Taxes............ 7.6 9.5 2.6 Net Income.......................................... 5.0 6.5 1.7 Years Ended December 31, 1999 and 1998 Net Sales. Net sales in the year ended December 31, 1999 increased from the corresponding period of 1998 by $13.1 million, or 9.1%, to $157.5 million. The increase in net sales primarily reflects increased volumes in North America and Asia Pacific, offset by decreased volume in Europe. In the year ended December 31, 1999, sales from international operations were 46.3% of total sales compared with 47.7% in the comparable period of 1998. This decrease primarily reflects lower touchscreen volume in Europe, offset by higher touchscreen volume in Asia Pacific, combined with the impact of increased sales in North America. Gross Profit. Gross profit for the year ended December 31, 1999 decreased from the year ended December 31, 1998 by $2.3 million or 4.0%, to $53.2 million. As a percentage of net sales, gross profit decreased from 38.4% in the year ended December 31, 1998 to 33.8% in the year ended December 31, 1999. The decrease in gross margin percent was primarily due to (a) a change in product mix reflecting a shift to flat touchscreens, which currently yield a lower gross profit, (b) the impact of expanding resistive touchscreen production at the Methuen plant, and (c) continued lower than historical gross profit in the Factura kiosk business, which has since been divested. 13 Research and Development. Research and development expenses for the year ended December 31, 1999 increased over the corresponding period of 1998 by $1.9 million, or 17.5%, to $12.8 million. As a percentage of net sales, research and development expenses increased from 7.6% in the year ended December 31, 1998 to 8.1% in the year ended December 31, 1999. The increase in spending both on an absolute dollar basis and as a percentage of net sales reflects the continued investment in programs to develop improvements in touchscreen technologies, especially a next generation version of capacitive and resistive products. Sales and Marketing. Sales and marketing expenses of $20.9 million for the year ended December 31, 1999 remained relatively flat with the corresponding period of 1998. As a percentage of net sales, sales and marketing expenses decreased from 14.7% for the year ended December 31, 1998 to 13.3% for the corresponding period of 1999. General and Administrative. General and administrative expenses for the year ended December 31, 1999 increased from the corresponding period of 1998 by $1.2 million, or 12.1%, to $11.2 million. As a percentage of net sales, general and administrative expenses increased slightly from 6.9% for the fiscal year ended December 31, 1998 to 7.1% for the corresponding period of 1999. The increase in spending both on an absolute dollar basis and as a percentage of net sales reflects increased Information Technology expenses, especially costs associated with the establishment of the Company's e-commerce website, Touchstore.com. Amortization of Intangible Assets. For the year ended December 31, 1999, operating expenses included $333,000 of amortization relating to various acquisitions and purchases of technologies, as compared to $502,000 for the corresponding period of 1998. Non-recurring Factura Charge. During the fourth quarter of 1999, the Company committed to a plan to dispose of its Factura kiosk business. As a result, the Company recorded a pre-tax non-recurring charge of $1,950,000 in the fourth quarter of 1999. On January 18, 2000, the Company completed the sale of certain of the assets of the Factura division to Factura Corporation, a new company partially owned by former management of the division. As a result of this transaction, the Company received cash and promissory notes in the approximate amount of $400,000 and will receive certain lease payments over a 5-year period. The Company may also receive additional payments based upon the buyer achieving certain specified revenue levels over the next five years The non-recurring charge includes (i) $43,000 associated with personnel reductions of approximately 12 positions at the Factura division prior to the sale, (ii) $417,000 associated with estimated lease costs for the Factura facility subsequent to the sale date (net of estimated sublease income), (iii) $210,000 associated with legal and other exit costs, and (iv) $1,280,000 associated with a loss on the sale of the non-cash assets of the Factura division. No amounts had been paid as of December 31, 1999. Included in the consolidated results of operations for 1997, 1998 and 1999 are Factura sales and operating income, respectively, of $7.7 million and $80,000 in 1997, and Factura sales and operating losses, respectively, of $6.9 million and $856,000 in 1998 and $4.4 million and $1.5 million in 1999. The loss on the sale consists primarily of the writedown to fair value of certain fixed assets and goodwill. Operating Income. Operating income for the fiscal year ended December 31, 1999 decreased from the $12.8 million amount reported for fiscal year 1998. This decrease is primarily due to the decrease in gross percent outlined above, as well as the non-recurring charge of $1.95 million related to Factura. Other Income, net. Other income in the year ended December 31, 1999 was $1.2 million as compared to $1.0 million for the corresponding period of 1998. Other income in the 1999 period included $1.1 million in interest income, net of interest expense, as compared to $1.5 million of net interest income for the year ended December 31, 1998. Foreign exchange gains were $135,000 in the year ended December 31, 1999, primarily due to currency fluctuations in the Far East, as compared to a loss of $340,000 for the corresponding period of 1998. Litigation Costs. During the first quarter of 1999, the Company recorded a charge of $3.3 million related to a judgement against the Company in a lawsuit. While the matter is continuing in post-trial proceedings, the Company has established a reserve for the full amount of the judgement, as well as estimated associated legal fees. (See Note 8 to Consolidated Financial Statements and "Business--Legal Proceedings".) 14 Provision for Income Taxes. The Company's effective tax rate for the years ended December 31, 1999 and 1998 was 32.0%. The 1999 effective tax rate differed from the federal statutory rate of 34% primarily as a result of the benefit related to tax-exempt interest income and the utilization of foreign net operating losses. Geographic Segments. Domestic pre-tax income of $527,000 represented a decrease of $8.8 million or 94% from 1998. This decrease in pre-tax profit is primarily the result of the $3.3 million litigation charge, the Factura $1.95 million non-recurring charge, and the impact of reduced gross margin percentages as discussed above. International pre-tax income of $3.4 million represented a decrease of $1.0 million or 23% from the corresponding period of 1998. This decrease was primarily due to the impact of reduced gross margin percentages especially in Europe, as discussed above. Years Ended December 31, 1998 and 1997 Net Sales. Net sales in the fiscal year ended December 31, 1998 increased from the corresponding period of 1997 by $15.9 million, or 12%, to $144.4 million. The increase in net sales primarily reflects increased international sales volume. Sales from international operations were $68.9 million or 47.7% of total sales and represented an increase of $15.0 million or 28% over international sales in the comparable period of 1997. This increase primarily reflects higher touchscreen volume into the European and Asia Pacific (excluding Japan) markets. Gross Profit. Gross profit for the fiscal year ended December 31, 1998 increased over the fiscal year ended December 31, 1997 by $10.5 million or 23%, to $55.4 million. As a percentage of net sales, gross profit increased from 35.0% in the fiscal year ended December 31, 1997 to 38.4% in the fiscal year ended December 31, 1998. The increase in gross margin percent primarily reflects the impact of a $2.3 million (pretax) special non-recurring charge related to the Company's whiteboard products in 1997, as well as increased touchscreen product yields and improved manufacturing efficiencies in 1998. Research and Development. Research and development expenses for the fiscal year ended December 31, 1998 increased over the corresponding period of 1997 by $2.9 million, or 37%, to $10.9 million. As a percentage of net sales, research and development expenses increased from 6.2% in the fiscal year ended December 31, 1997 to 7.6% in the fiscal year ended December 31, 1998. The increase in spending both on an absolute dollar basis and as a percentage of net sales reflects the initiation of a program to develop a next generation capacitive product line with improved performance and cost savings over the existing product line, as well as advancing its resistive technology The Company expects that total research and development expenses will most likely increase in the future on an absolute spending basis and as a percentage of net sales primarily due to the research on the Company's core touchscreen technology. Sales and Marketing. Sales and marketing expenses for the fiscal year ended December 31, 1998 increased over the corresponding period of 1997 by $2.5 million, or 13%, to $21.2 million. As a percentage of net sales, sales and marketing expenses increased slightly from 14.6% for the fiscal year ended December 31, 1997 to 14.7% for the corresponding period of 1998. The increase in absolute spending in 1998 was also the result of sales costs associated with supporting large OEM customers and expanding the Company's Internet presence, as well as the development of a remote sales information systems sales program. General and Administrative. General and administrative expenses for the fiscal year ended December 31, 1998 increased from the corresponding period of 1997 by $2.1 million, or 26%, to $10.0 million. As a percentage of net sales, general and administrative expenses increased from 6.2% for the fiscal year ended December 31, 1997 to 6.9% for the corresponding period of 1998, primarily as a result of spending to improve systems supporting the Company's infrastructure in the Information Technology and E-commerce areas and legal expenses. Amortization of Intangible Assets. For the fiscal year ended December 31, 1998, operating expenses included $502,000 of amortization relating to various acquisitions and purchases of technologies, as compared to $477,000 for the corresponding period of 1997. 15 Operating Income. Operating income for the fiscal year ended December 31, 1998 of $12.8 million represented an increase of $3.0 million, or 31%, over the fiscal year ended December 31, 1997. This increase is primarily due to the revenue increase discussed above and the absence of the previously discussed special whiteboard restructuring charge of $2.3 million taken in 1997. Other Income, net. Other income in the fiscal year ended December 31, 1998 was $1.0 million as compared to $0.6 million for the corresponding period of 1997. Other income in the 1998 period included $1.5 million in interest income, net of interest expenses, as compared to $1.4 million of net interest income for the fiscal year ended December 31, 1997. Foreign exchange losses were $340,000 in the fiscal year ended December 31, 1998, primarily due to currency fluctuations in the Far East, as compared to a loss of $999,000 for the corresponding period of 1997. Arbitration Costs. During 1997, the Company expensed a final payment amounting to $595,000 in its international arbitration versus Nissha Printing Company Ltd. (See Note 8 to Consolidated Financial Statements) Provision for Income Taxes. The Company's effective tax rate for the fiscal years ended December 31, 1998 and 1997 was 32.0% and 34.2%, respectively. The effective tax rates differed from the federal statutory rate of 34% primarily as a result of the provision for state income taxes partially offset by the benefit related to tax-exempt interest income. Geographic Segments. Domestic pre-tax income of $9.3 million represented an increase of $1.8 million or 24% over 1997. This increase in pre-tax profit primarily reflects the impact of the $2.3 million non-recurring charge taken in 1997. International pretax income of $4.4 million represented an increase of $2.2 million or 101% over the corresponding period of 1997 on the strength of the previously discussed international sales increases and improved gross margins. Liquidity and Capital Resources As of December 31, 1999, the Company had net working capital of $46.8 million, including approximately $19.9 million in cash and marketable securities. The Company reported a net cash flow from operating activities of $1.3 million for the year ended December 31, 1999. Additionally, the Company maintains a $7.5 million bank line of credit, including letters of credit, in the U.S. and a $2.4 million bank line of credit in the U.K. As of December 31, 1999, the Company had $3.1 million outstanding under the U.S. line of credit and $1.5 million outstanding under the U.K line of credit. The Company's capital expenditures were approximately $7.7 million in 1999. During 1999, the Board of Directors of the Company approved additional extensions to a repurchase program of the Company's common stock, originally approved in December 1997 and extended during 1998. Under the 1999 extensions, the amount of common stock to be repurchased is not to exceed $13.0 million. In the year ended December 31, 1999, the Company repurchased approximately 894,000 shares at an aggregate cost of $12.8 million, of which 168,000 shares at an aggregate cost of $2.2 million relate to extensions approved in 1998. These shares have been and will be used for the Company's stock option plans, employee stock purchase plan and for other corporate purposes, possibly including acquisitions. Pending operational needs, the Company has invested its cash in investment grade, short term, interest-bearing securities. The Company believes that these investments, together with anticipated cash flows from operations pursuant to its current operating plan, will be sufficient to meet the Company's working capital and capital expenditure requirements at least through 2001. While the Company regularly evaluates acquisition candidates, conducts preliminary discussions regarding acquisitions and may pursue acquisition opportunities available to it, there can be no assurance that any such acquisition will be made or, if made, whether such acquisition will be financially successful. 16 Foreign Exchange Exposure Significant portions of the Company's operations are conducted in foreign countries, including the United Kingdom of Great Britain, Germany, France, Italy, Spain, Australia, Taiwan, Japan, Hong Kong and Korea. Exchange rate fluctuations between the U.S. dollar and the currencies of these countries, including various European currencies and the Australian dollar, result in fluctuations in the amounts relating to foreign operations reported in the Company's consolidated financial statements. In general, the Company's policy is not to enter into derivative financial instruments or other financial instruments to manage foreign currency exchange rate risk. The Company can provide no assurances that it will not enter into such financial instruments in the future. Supply Exposure Although the Company generally uses standard parts for its product, certain components, such as ASICs, topsheets and the coated glass used in the production of touch sensors, are currently available only from a single source. In the event that suppliers are unable to fulfill the Company's requirements, the resulting interruption in production would have an adverse impact on the Company's operating results. While the Company maintains some inventory of ASICs, coated glass and other components, the inventory amounts maintained are not sufficient to eliminate the potential impact of prolonged supply interruptions. While the Company believes that there are other companies that are capable of manufacturing these sole source components, the inability to obtain sufficient components as required, or to develop alternative sources if and when needed, would adversely affect the Company's operating results. Year 2000 Compliance During 1999 the Company completed its Year 2000 readiness program. In connection with this program, the Company converted or upgraded, and tested, all systems and products that had material Year 2000 compliance issues. The Company has not segregated the cost of making these items compliant as the related software conversion or upgrades were installed by existing employees and consultants of the Company in conjunction with their normal duties, and would have been purchased in the normal course of business. Subsequent to December 31, 1999, the Company has not experienced any material Year 2000 transition issues. However, there can be no assurance that a material customer or vendor will not experience a Year 2000 transition issue, or that such transition issue will not have a material negative impact on the Company's consolidated financial position, results of operations, or cash flow. 17 Item 8. Financial Statements and Supplementary Data 1.Financial Statements Page No. -------- Report of Independent Public Accountants............................. F-1 Consolidated Balance Sheets as of December 31, 1998 and 1999......... F-2 Consolidated Statements of Operations and Comprehensive Income for each of the three years in the period ended December 31, 1999....... F-3 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1999......................... F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1999.................................. F-5 Notes to Consolidated Financial Statements........................... F-6 18 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To MicroTouch Systems, Inc: We have audited the accompanying consolidated balance sheets of MicroTouch Systems, Inc (a Massachusetts corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999 These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of MicroTouch Systems, Inc and subsidiaries as of December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14(a)(2) is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP ------------------------------------- ARTHUR ANDERSEN LLP Boston, Massachusetts January 26, 2000 F-1 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) December 31, ------------------ 1998 1999 -------- -------- ASSETS Current assets: Cash and cash equivalents (Note 1)....................... $ 5,471 $ 4,329 Marketable securities (Note 1)........................... 32,191 15,566 Accounts receivable, net of allowances of $4,955 and $1,701 at December 31, 1998 and 1999, respectively...... 23,265 30,387 Inventories (Note 1)..................................... 15,954 18,014 Deferred income taxes (Note 4)........................... 6,837 4,854 Prepaid expenses and other current assets................ 1,217 1,177 -------- -------- Total current assets................................... 84,935 74,327 Property and equipment, at cost (Note 1) Machinery and equipment.................................. 16,070 23,361 Furniture and fixtures................................... 1,560 1,930 Leasehold improvements................................... 4,283 4,220 Land and buildings....................................... 6,426 6,516 -------- -------- 28,339 36,027 Less--Accumulated depreciation and amortization............ 10,887 15,052 -------- -------- Net property and equipment............................. 17,452 20,975 Other assets............................................... 1,958 1,802 -------- -------- Total assets............................................... $104,345 $ 97,104 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable (Note 2)................................... $ 3,760 $ 4,635 Accounts payable......................................... 9,336 10,190 Accrued payroll and related costs........................ 3,011 2,763 Accrued expenses......................................... 9,768 9,938 -------- -------- Total current liabilities.............................. 25,875 27,526 Long-term notes payable.................................... 101 70 -------- -------- Total liabilities...................................... 25,976 27,596 Stockholders' equity (Note 3) Preferred stock, $.01 par value per share--500,000 shares authorized, none issued and outstanding at December 31, 1998 and 1999........................................... -- -- Common stock, $.01 par value per share--20,000,000 shares authorized, 8,256,128 and 8,379,861 shares issued at December 31, 1998 and 1999, respectively................ 82 84 Additional paid-in capital............................... 62,613 64,107 Treasury stock at cost, 959,576 and 1,853,276 shares at December 31, 1998 and 1999, respectively................ (13,503) (26,292) Accumulated other comprehensive loss..................... (1,382) (1,621) Retained earnings........................................ 30,559 33,230 -------- -------- Total stockholders' equity............................. 78,369 69,508 -------- -------- Total liabilities and stockholders' equity............... $104,345 $ 97,104 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. F-2 MICROTOUCH SYSTEMS, INC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except share and per share data) Year Ended December 31, ---------------------------- 1997 1998 1999 -------- -------- -------- Net sales (Notes 1 and 6)........................ $128,481 $144,370 $157,491 Cost of sales.................................... 83,553 88,950 104,323 -------- -------- -------- Gross profit................................. 44,928 55,420 53,168 Operating expenses: Research and development....................... 7,985 10,904 12,816 Sales and marketing............................ 18,765 21,235 20,862 General and administrative..................... 7,944 10,012 11,225 Amortization of intangibles.................... 477 502 333 Non-recurring charge........................... -- -- 1,950 -------- -------- -------- Total operating expenses..................... 35,171 42,653 47,186 -------- -------- -------- Operating income........................... 9,757 12,767 5,982 Other income, net................................ 579 1,009 1,249 Arbitration/litigation costs (Note 8)............ 595 -- 3,303 -------- -------- -------- Income before income taxes....................... 9,741 13,776 3,928 Income taxes (Note 4)............................ 3,330 4,408 1,257 -------- -------- -------- Net income....................................... $ 6,411 $ 9,368 $ 2,671 ======== ======== ======== Earnings per share (Note 1): Basic.......................................... $ 0.81 $ 1.22 $ 0.39 Diluted........................................ $ 0.77 $ 1.20 $ 0.38 Weighted average and dilutive potential common shares outstanding (Note 1): Basic.......................................... 7,941 7,672 6,914 Diluted........................................ 8,349 7,815 7,065 Comprehensive income: Net income....................................... $ 6,411 $ 9,368 $ 2,671 Currency translation adjustment.................. (558) (523) (60) Unrealized gain (loss) on marketable securities, net of tax expense (benefit) of $(10), $70 and $(84)........................................... (21) 148 (179) -------- -------- -------- Comprehensive income............................. $ 5,832 $ 8,993 $ 2,432 ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. F-3 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data) Accumulated Common Stock Additional Other Treasury Stock Total ---------------- Paid-in Comprehensive Retained -------------------- Stockholders' Shares Amount Capital Income (loss) Earnings Shares Amount Equity --------- ------ ---------- ------------- -------- ---------- -------- ------------- Balance December 31, 1996................... 8,220,623 $ 82 $60,096 $ (428) $17,383 (536,140) $ (7,963) $69,170 Exercise of stock options................ (2,551) 310,979 4,560 2,009 Employee stock purchase plan................... 42 28,112 416 458 Compensation expense related to common stock options................ 30 30 Effect of exchange rate changes................ (558) (558) Tax benefit related to exercise of stock options and disqualifying dispositions........... 1,795 1,795 Unrealized loss on securities available for sale, net of tax... (21) (21) Purchase of treasury stock.................. (23,000) (346) (346) Net income.............. 6,411 6,411 --------- ---- ------- -------- ------- ---------- -------- ------- Balance December 31, 1997................... 8,220,623 82 61,963 (1,007) 21,243 (220,049) (3,333) 78,948 Exercise of stock options................ 15,632 247 (52) 8,725 111 306 Employee stock purchase plan................... 19,873 205 15,048 227 432 Compensation expense related to common stock options................ 198 198 Effect of exchange rate changes................ (523) (523) Unrealized gain on securities available for sale, net of tax... 148 148 Purchase of treasury stock.................. (763,300) (10,508) (10,508) Net income.............. 9,368 9,368 --------- ---- ------- -------- ------- ---------- -------- ------- Balance December 31, 1998................... 8,256,128 82 62,613 (1,382) 30,559 (959,576) (13,503) 78,369 Exercise of stock options................ 79,719 1 772 773 Employee stock purchase plan................... 44,014 1 479 480 Compensation expense related to common stock options................ 30 30 Effect of exchange rate changes................ (60) (60) Tax benefit related to exercise of stock options and disqualifying dispositions........... 213 213 Unrealized loss on securities available for sale, net of tax... (179) (179) Purchase of treasury stock.................. (893,700) (12,789) (12,789) Net income.............. 2,671 2,671 --------- ---- ------- -------- ------- ---------- -------- ------- Balance December 31, 1999................... 8,379,861 $ 84 $64,107 $ (1,621) $33,230 (1,853,276) $(26,292) $69,508 ========= ==== ======= ======== ======= ========== ======== ======= The accompanying notes are an integral part of these consolidated financial statements. F-4 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, ---------------------------- 1997 1998 1999 -------- -------- -------- Cash flows from operating activities: Net income...................................... $ 6,411 $ 9,368 $ 2,671 Adjustments to reconcile net income to net cash provided by operating activities-- Depreciation and amortization.................. 3,116 5,870 4,959 Compensation expense related to common stock options....................................... 30 198 30 Tax benefit from exercise of stock options and disqualifying dispositions.................... 1,795 -- 213 (Increase) decrease in assets-- Accounts receivable........................... (1,372) (5,917) (7,122) Inventories................................... (3,998) 3,121 (2,060) Prepaid expenses and other current assets..... (52) (106) 40 Deferred income taxes......................... (1,364) 32 1,983 Other assets.................................. 750 (60) (177) Increase (decrease) in liabilities-- Accounts payable.............................. (1,177) 3,487 854 Accrued expenses.............................. 1,188 2,739 (78) -------- -------- -------- Net cash provided by operating activities.... 5,327 18,732 1,313 Cash flows from investing activities: Purchase of property and equipment, net......... (8,551) (9,540) (7,688) Sale and maturity of marketable securities...... 16,287 12,240 17,372 Purchase of marketable securities............... (14,967) (19,006) (1,387) -------- -------- -------- Net cash provided by (used in) investing activities.................................. (7,231) (16,306) 8,297 Cash flows from financing activities: Exercise of stock options and sale of common stock, net..................................... 2,467 738 1,253 Increase in notes payable....................... -- 3,861 844 Purchase of treasury stock...................... (346) (10,508) (12,789) -------- -------- -------- Net cash provided by (used in) financing activities.................................. 2,121 (5,909) (10,692) Effect of exchange rates on cash................. (558) (523) (60) -------- -------- -------- Net decrease in cash and cash equivalents........ (341) (4,006) (1,142) Cash and cash equivalents, beginning of period... 9,818 9,477 5,471 -------- -------- -------- Cash and cash equivalents, end of period......... $ 9,477 $ 5,471 $ 4,329 ======== ======== ======== Supplemental disclosures of cash flow information: Interest paid................................... $ 30 $ 135 $ 136 ======== ======== ======== Income taxes paid............................... $ 3,369 $ 1,929 $ 4,201 ======== ======== ======== The accompanying notes are an integral part of these consolidated statements. F-5 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1) Summary of Significant Accounting Policies a) Nature of the Business MicroTouch Systems, Inc. develops, manufactures and sells touch and pen input systems, including touch sensitive screens, digitizers for pen computers, ThruGlass products, and electronic P.C whiteboards. b) Principles of Consolidation The accompanying consolidated financial statements include the accounts of MicroTouch Systems, Inc. and its wholly owned subsidiaries (together, the "Company"). All significant intercompany accounts, transactions and profits have been eliminated. c) Earnings per Share In 1997, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No 128, Earnings Per Share. Basic earnings per share is computed using the weighted average number of common shares outstanding during the year. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and are calculated using the treasury stock method. Included in diluted earnings per share are 408,000, 143,000 and 151,000 dilutive potential common shares for 1997, 1998 and 1999, respectively. Excluded from diluted earnings per share were options to purchase 12,000, 585,000 and 943,000 shares in 1997, 1998 and 1999, respectively. These shares were excluded as the exercise price was greater than the average market price of the common shares during the respective years. d) Cash and Cash Equivalents The Company held no liquid investments with original maturities of less than 90 days at December 31, 1998 or December 31, 1999. Cash equivalents are stated at cost, which approximates market value. e) Marketable Securities Marketable securities consist of investment-grade, federal tax-exempt municipal bonds. The aggregate market value, cost basis, and unrealized gains and losses of securities available for sale, by major security type, as of December 31, 1999 and 1998 are as follows: Gross Gross Market Unrealized Unrealized Value Cost Basis Gains Losses ----------- ----------- ---------- ---------- Tax Exempt Securities at December 31, 1998.............. $32,191,000 $31,850,000 $344,000 $ 3,000 =========== =========== ======== ======== Tax Exempt Securities at December 31, 1999.............. $15,566,000 $15,710,000 $ 7,000 $151,000 =========== =========== ======== ======== Securities available for sale in the accompanying balance sheet at December 31, 1998 and 1999 include $7,782,000 and $4,454,000 respectively, with contractual maturities of one year or less, $23,346,000 and $10,158,000 respectively, with contractual maturities of one through five years and $1,063,000 and $954,000 respectively, with maturities of more than five years. Expected maturities may differ from contractual maturities as a result of the Company's intent to sell these securities prior to maturity and as a result of call options that enable the issuer to redeem these securities at an earlier date. F-6 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) f) Inventories Inventories, consisting of material, material overhead, labor and manufacturing overhead, are stated at the lower of cost (first-in, first-out) or market and consist of the following: December 31, ----------------------- 1998 1999 ----------- ----------- Raw materials..................................... $ 6,286,000 $ 5,231,000 Work-in-process................................... 1,167,000 3,608,000 Finished goods.................................... 8,501,000 9,175,000 ----------- ----------- $15,954,000 $18,014,000 =========== =========== g) Property and Equipment The Company provides for depreciation and amortization, using the straight- line method, through charges to operations in amounts that allocate the cost of property and equipment over their estimated useful lives. The estimated useful life for property and equipment is 3 to 7 years except for a building owned by the Company, the life of which is 25 years. Maintenance and repairs are charged to operations as incurred. When property and equipment is sold or otherwise disposed of, the asset cost and accumulated depreciation are removed from the accounts, and the resulting gain or loss, if any, is included in the results of operations. h) Revenue Recognition The Company recognizes product revenue upon shipment. Service revenues are recognized as the services are provided. The Company provides allowances for estimated sales returns and bad debts and provides for the estimated cost of warranty at the time of product shipment. i) Foreign Currency Translation The Company translates the assets and liabilities of its foreign subsidiaries at the exchange rates in effect at year end. Revenues and expenses are translated using exchange rates in effect during the year. Gains and losses from foreign currency translation are credited or charged to cumulative translation adjustment included in stockholders' equity in the accompanying consolidated balance sheets. Gains and losses from foreign currency transactions are included in other income and amounted to a loss of approximately $999,000 for the year ended December 31,1997, a loss of approximately $340,000 for the year ended December 31, 1998 and a gain of approximately $135,000 for the year ended December 31, 1999. j) Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. k) Disclosures About Fair Value of Financial Instruments SFAS No 107, Disclosures About Fair Value of Financial Instruments, requires that disclosure be made of estimates of the fair value of each class of financial instrument. Financial instruments held by the Company as of December 31, 1999 consist primarily of cash equivalents and marketable securities, short-term trade receivables, payables and notes payable for which the carrying amounts approximate fair values. F-7 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) l) Capitalized Software Development Costs Software development costs for new software and for enhancements to existing software are expensed as incurred prior to the establishment of technological feasibility and subsequent to general release of the product. Otherwise software development costs are capitalized and amortized over the estimated life of the product. There were no capitalized software costs as of December 31, 1998 and 1999. m) Other Assets The Company periodically assesses the realizability of its long-lived assets in accordance with SFAS No 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. At each balance sheet date, the Company evaluates the realizability of goodwill based on expectations of non-discounted future cash flows for each subsidiary having a material goodwill balance. If the sum of the expected non-discounted future cash flow is less than the carrying amount of goodwill, the Company would recognize an impairment loss. n) Comprehensive Income Effective January 1, 1998 the Company adopted the provisions of SFAS No 130, Reporting Comprehensive Income, which establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Comprehensive income includes all non-owner related changes in a company's equity including, among other things, foreign currency translation adjustments and unrealized gains and losses on marketable securities classified as available-for-sale. Because cumulative translation adjustments are considered a component of permanently invested unremitted earnings of subsidiaries outside of the United States, no taxes are provided on such amounts. o) Recent Accounting Pronouncements In March 1998, The American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires computer software costs associated with internal use software to be expensed as incurred until certain capitalization criteria are met. The adoption of SOP 98-1 did not have a material impact on the Company's financial statements. In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of Start-up Activities. SOP 98-5 requires all costs associated with pre-opening, pre- operating and organization activities to be expensed as incurred. The Company adopted SOP 98-5 effective January 1, 1999. The adoption of SOP 98-5 did not have a material impact on the Company's financial statements. In June 1998, the FASB issued SFAS No 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No 137, issued in June 1999, deferred the effective date of SFAS No 133 to fiscal years beginning after June 15, 2000. 2) Line of Credit The Company has demand bank lines of credit in the U.S totaling $7,500,000, including letters of credit, under which the Company may borrow on an unsecured basis at the bank's prime rate. There was a balance of $2,264,000 outstanding under these lines at December 31, 1998 and $3,105,000 outstanding at December 31, 1999. F-8 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company has a demand bank line of credit in the United Kingdom in the amount of approximately $2,400,000 under which the Company may borrow on a secured basis at a negotiated rate. There was a balance of $1,500,000 outstanding under this line at December 31, 1998 and $1,530,000 outstanding at December 31, 1999. 3) Stockholders' Equity a) Equity Incentive Plans In 1992, the stockholders of the Company approved the 1992 Equity Incentive Plan (the 1992 Plan) which replaced the Company's 1983 Incentive Stock Option Plan (the 1983 Plan). In June 1997 and 1998, the 1992 Plan was amended by the stockholders of the Company. The 1992 Plan, as amended, authorizes the grant of stock options (incentive and non-qualified), stock appreciation rights (SARs), performance shares or restricted stock (individually and collectively, the Awards) for the purchase of an aggregate of 2,750,000 shares of common stock, including shares that are issuable pursuant to outstanding stock options under the 1983 Plan. Incentive stock options will be granted at not less than the fair market value at the date of grant. Non-qualified stock options will be granted at not less than 50% of the fair market value at the date of grant. Options granted on or before July 31, 1998 vest ratably over four years. Options granted after July 31, 1998 vest over three years at a rate of 20% in the first year and 40% in each of the second and third years. At December 31, 1999, options to purchase 1,472,727 shares of common stock were outstanding and 341,818 shares of common stock were available for future grants under the 1992 Plan. As of December 31, 1999, no SARs, performance shares or other restricted stock have been awarded under the 1992 Plan. In 1998, the Board of Directors adopted a new stock option plan (the 1998 Plan). The 1998 Plan authorizes the grant of non-qualified stock options (the Awards) for the purchase of an aggregate of 1,000,000 shares of common stock. Options will be granted at not less than the fair market value at the date of grant and generally vest over three years. At December 31, 1999, options to purchase 266,800 shares of common stock were outstanding and 733,200 shares of common stock were available for future grants under the 1998 Plan. The Board of Directors has appointed the Compensation Committee (the Committee) to administer the 1992 Plan and the 1998 Plan. The Committee generally selects the individuals who will receive the Awards, and the terms and conditions of those Awards. In 1993, options to purchase 200,000 shares were granted to the Company's Chairman of the Board of Directors under a 10 year performance incentive agreement pursuant to the 1992 Plan. As of December 31, 1999, 160,000 shares have been exercised and the remaining 40,000 shares, which are included in the 1992 Plan above, were exercisable under this grant. In 1994, the Board of Directors adopted the 1994 Director Stock Option Plan (the 1994 Plan) which was approved by the stockholders at the 1995 annual stockholders' meeting The 1994 Plan authorizes the grant of non-qualified stock options to all directors of the Company who are not employees of the Company or any of its subsidiaries. An aggregate of 200,000 shares of common stock have been authorized for issuance under the 1994 Plan. The Board of Directors administers the 1994 Plan. Under the terms of the 1994 Plan, as amended, each non-employee director, upon initial election to the Board of Directors, shall receive options to purchase 10,000 shares of common stock. In lieu of grants upon election, current directors received initial grants upon the effective date of the adoption of the 1994 Plan. Immediately following the annual meeting of the stockholders each year, each non-employee director of the Company continuing in office shall automatically be granted options to purchase 5,000 shares of common stock. Options will be granted at not less than fair market value Options granted before June 24, 1998 generally vested over two years. Options granted on or after June 24, 1998 vest over three years. At December 31, 1999, options to purchase 102,500 shares of common stock were outstanding and 62,500 shares of common stock were available for future grants under the 1994 Plan. F-9 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following is a summary of the stock option activity for the years ended December 31, 1997, 1998 and 1999: Number of Exercise Price Shares per Share --------- -------------- Outstanding at December 31, 1996..................... 1,169,200 $1.75 - $25.75 Granted............................................ 385,307 15.75 - 31.50 Terminated......................................... (60,043) 6.19 - 26.00 Exercised.......................................... (310,979) 1.75 - 17.81 --------- Outstanding at December 31, 1997..................... 1,183,485 1.75 - 31.50 Granted............................................ 516,745 11.81 - 19.25 Terminated......................................... (109,873) 7.75 - 31.50 Exercised.......................................... (24,357) 6.19 - 16.89 --------- Outstanding at December 31, 1998..................... 1,566,000 1.75 - 31.50 Granted............................................ 443,350 11.88 - 17.13 Terminated......................................... (87,604) 12.81 - 31.50 Exercised.......................................... (79,719) 1.75 - 15.75 --------- Outstanding at December 31, 1999..................... 1,842,027 $1.75 - $31.50 ========= The following is a summary of options outstanding and exercisable at December 31, 1999: Options Outstanding Options Exercisable --------------------------------------------- ---------------------------- Number Weighted Average Number Range of Outstanding Weighted Average Remaining Exercisable Weighted Average ExercisePrices At 12/31/99 Exercise Price Contractual Life At 12/31/99 Exercise Price - -------------- ----------- ---------------- ---------------- ----------- ---------------- $1.75 - $12.81 528,900 $ 9.77 3.9 218,425 $ 5.50 $12.82 - $15.13 384,987 14.86 5.7 201,280 14.87 $15.25 - $15.56 394,946 15.51 5.0 89,616 15.51 $15.63 - $19.75 370,844 18.32 6.3 176,682 18.06 $20.56 - $31.50 162,350 23.64 6.8 104,176 23.49 --------- ------- 1,842,027 $15.01 5.3 790,179 $14.20 ========= ======= The Company accounts for stock options at intrinsic value with disclosure of the effects of fair value accounting on net income and earnings per share on a pro forma basis. Had compensation costs for the stock option plans been determined using the fair value method, the Company's pro forma net loss, basic and diluted loss per share would have been $0.5 million, $.07 and $.07 respectively for the fiscal year ended December 31, 1999. The Company's pro forma net income, basic and diluted earnings per share would have been $7.0 million, $.91 and $.89 respectively for the fiscal year ended December 31, 1998 and $3.9 million, $.49 and $.47, respectively for the fiscal year ended December 31, 1997 Pro forma net income and earnings per share have not been calculated for options granted prior to January 1, 1995. Pro forma compensation cost may not be representative of that to be expected in future years. The weighted average fair values of all options granted in 1997, 1998 and 1999 were $9.79, $7.22 and $7.65, respectively. The values were estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1997, 1998 and 1999, respectively: risk free interest rate of 6.3%, 5.7% and 5.1%, expected dividend yields of zero for all periods, expected option lives of 5 years for all options granted in 1997 and 1998 and 4 years for options granted in 1999, and expected volatility of 69%, 66% and 64%. F-10 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) b) Shareholder Rights Plan In January 1996, the Company adopted a Shareholder Rights Plan and declared a dividend distribution of one right for each outstanding share of the Company's common stock to stockholders of record on January 19, 1996 and authorized the issuance of one right for each share of the Company's common stock issued between January 19, 1996 and the date on which the right becomes separable from the common stock. Each right entitles the shareholders to buy from the Company 1/100 of a share of Series A Junior Participating Preferred Stock, $.10 par value, at a purchase price of $75 per right. The rights will be exercisable or separable from the common stock until ten business days after a party acquires beneficial ownership of 20% or more of the Company's common stock or announces a tender offer for at least 20% of its common shares outstanding. The rights are subject to adjustment and may be redeemed by the Company at a price of $0.01 per right at any time until the tenth day following the point at which they become exercisable. In the event that the Company is acquired in a merger or other business combination transaction, each right, other than those held by the acquiring party, will entitle its holders to purchase an amount of shares of the Company's common stock which equals the exercise price of the rights divided by one-half of the current market price of the common stock. The rights will expire, unless earlier redeemed or exchanged, on January 19, 2006, or earlier in certain circumstances. 4) Income Taxes The Company accounts for income taxes in accordance with SFAS No 109, "Accounting for Income Taxes." Provisions for income taxes recognize the tax effect of all revenue and expense transactions as well as any changes during the period in deferred tax assets and liabilities. The effects of changes in tax rates and laws on deferred tax assets and liabilities are reflected in net income in the period in which such changes are enacted. The components of domestic and foreign income before the provision for income taxes are as follows: Year Ended December 31, ------------------------------------ 1997 1998 1999 ----------- ------------ ----------- Domestic............................. $ 7,531,000 $ 9,336,000 $ 527,000 Foreign.............................. 2,210,000 4,440,000 3,401,000 ----------- ------------ ----------- Total.............................. $ 9,741,000 $ 13,776,000 $ 3,928,000 =========== ============ =========== The provision for federal, state and foreign income taxes consists of the following: 1997 1998 1999 --------------------------------- --------------------------------- ------------------------------------- Federal State Foreign Federal State Foreign Federal State Foreign ----------- --------- --------- ----------- --------- ----------- ------------ ---------- ----------- Current......... $ 2,903,000 $ 862,000 $ 929,000 $ 2,449,000 $ 247,000 $ 1,680,000 $ (1,567,000) $ (229,000) $ 1,070,000 Deferred/(Prepaid).. (1,052,000) (312,000) -- 20,000 12,000 -- 1,706,000 277,000 -- ----------- --------- --------- ----------- --------- ----------- ------------ ---------- ----------- $ 1,851,000 $ 550,000 $ 929,000 $ 2,469,000 $ 259,000 $ 1,680,000 $ 139,000 $ 48,000 $ 1,070,000 =========== ========= ========= =========== ========= =========== ============ ========== =========== Significant items making up net deferred tax assets as of December 31, 1998 and 1999 are as follows: Year Ended December 31, ----------------------- 1998 1999 ----------- ----------- Reserves for inventories......................... $ 1,410,000 $ 531,000 Reserves for accounts receivable................. 1,569,000 430,000 Reserves for warranty............................ 790,000 431,000 Other reserves and accruals...................... 3,068,000 3,462,000 ----------- ----------- Net deferred tax assets........................ $ 6,837,000 $ 4,854,000 =========== =========== F-11 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The amount computed by applying the federal statutory income tax rate of 34% to income before provision for income taxes differs from the Company's provision for income taxes due to the following: Year Ended December 31, ------------------------------------- 1997 1998 1999 ----------- ----------- ----------- Provision at federal statutory rate............................ $ 3,312,000 $ 4,684,000 $ 1,336,000 State taxes, net of federal benefit......................... 479,000 171,000 31,000 Foreign operating losses not (benefited)..................... 135,000 138,000 (262,000) Tax-exempt interest benefit...... (392,000) (436,000) (304,000) Foreign sales corporation benefit......................... (551,000) -- (128,000) Other, net....................... 347,000 (149,000) 584,000 ----------- ----------- ----------- $ 3,330,000 $ 4,408,000 $ 1,257,000 =========== =========== =========== 5) Commitments a) Royalty Agreement The Company is a party to a licensing agreement in which it has acquired the rights to various touch screen products and technologies. The licensing agreement provides for the payment of royalties based on annual product sales and sublicensing revenue and includes minimum royalty payment provisions. The agreement will be in effect until the expiration of the last-to-expire patent licensed under this agreement, which is in 2005. b) Leased Facilities The Company conducts its operations primarily in leased facilities under operating lease arrangements expiring on various dates through September 2006. Total rent expense under all leases for the years ended December 31, 1997, 1998 and 1999 was approximately $1,889,000, $1,543,000 and $2,224,000, respectively. Future minimum lease payments for all noncancelable leases are as follows: Fiscal Year Ending Amount - ------------------ ----------- 2000................................................................ $ 1,655,000 2001................................................................ 1,505,000 2002................................................................ 1,378,000 2003................................................................ 708,000 2004................................................................ 398,000 2005 and thereafter................................................. 620,000 ----------- Total............................................................. $ 6,264,000 =========== c) Post-retirement Benefits The Company does not offer any post-retirement or post-employment benefits to its employees. 6) Segment Information Effective January 1, 1998, the Company adopted SFAS No 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No 131 establishes standards for reporting information about operating segments in annual financial statements and interim financial reports issued to shareholders It also establishes F-12 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) standards for related disclosures about products and services, geographic areas, and major customers. The Company operates in one industry segment consisting of the development, manufacture and sale of touch sensitive input systems. The Company's technologies are managed as one segment, or one strategic unit, because it offers similar products in similar markets and the factors determining strategic decisions are comparable for all products and markets. Geographic area information for the years ended December 31, 1997, 1998 and 1999 is as follows: United Kingdom of Other Domestic Great Britain International Consolidated ------------ -------------- ------------- ------------- Year Ended December 31, 1997 Net sales............. $ 74,555,000 $ 35,011,000 $ 18,915,000 $ 128,481,000 Income (loss) before provision for income taxes................ 7,531,000 (211,000) 2,421,000 9,741,000 Identifiable assets... 71,649,000 16,235,000 6,953,000 94,837,000 Year Ended December 31, 1998 Net sales............. $ 75,511,000 $ 50,108,000 $ 18,751,000 $ 144,370,000 Income before provision for income taxes................ 9,336,000 4,119,000 321,000 13,776,000 Identifiable assets... 78,065,000 14,984,000 11,296,000 104,345,000 Year Ended December 31, 1999 Net sales............. $ 84,544,000 $ 44,617,000 $ 28,330,000 $ 157,491,000 Income before provision for income taxes................ 527,000 909,000 2,492,000 3,928,000 Identifiable assets... 63,786,000 15,468,000 17,850,000 97,104,000 Intercompany transfers to the Company's foreign subsidiaries are transacted at prices intended to allow the subsidiaries' earnings to be comparable to unaffiliated distributors. Sales to unaffiliated customers outside the United States, including U.S export sales, were approximately $57,409,000 in 1997, $71,351,000 in 1998, and $75,952,000 in 1999, which represented 45%, 49% and 48% of net sales, respectively. No single customer represented more than 10% of total sales during the years ended December 31, 1998 or 1999. 7) Retirement Savings Plan The Company has a 401(k) employee savings plan established in 1993 covering substantially all employees. Matching company contributions are at the discretion of the Board of Directors. Effective in 1998, the Board authorized matching contributions up to $900 of participants' contributions. Company contributions and other expenses of the Plan amounted to $156,000 in 1997, $306,000 in 1998 and $306,000 in 1999. 8) Legal Proceedings The Company had been involved in an international arbitration entitled MicroTouch Systems, Inc v Nissha Printing Co Ltd., ("Nissha") which was under the auspices of the International Chamber of Commerce ("ICC"). The case was based on the Company's claims that Nissha breached noncompetition provisions and other terms of a distribution agreement between the Company and Nissha. In January 1997, the Company was informed that while it had won the case based on the merits of its claims, any recovery of damages was time barred under the terms of the original agreement between the two parties in the dispute. As a result, the Company was required to pay a portion of Nissha's fees and costs related to the F-13 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) arbitration, in the amount of $595,000. The Company expensed these fees and costs awarded to Nissha as a part of its second quarter 1997 financial results. This payment completed the Company's involvement in the matter. The Company is a defendant in a case entitled Behne v MicroTouch Systems, Inc., in the United States District Court in the Northern District of California. The case arose from claims by Ms Behne, a former employee of MicroTouch, that the Company had discriminated against her during her employment at the Company. In March 1999, a jury found the Company not liable on the discrimination and retaliation claims, but awarded the plaintiff approximately $2,600,000 in compensatory and punitive damages under a related misrepresentation claim. While the matter continues under the appeals process, the Company has established a reserve for the full amount of the initial jury judgement, as well as associated legal fees, in the amount of $3,303,000, of which approximately $2,900,000 remained in the reserve at December 31, 1999. The Company continues to believe that the claims are without merit but no assurances can be given as to the outcome of this legal matter during the appeal process. The Company is subject to various investigations, claims and legal proceedings covering a wide range of matters that arise in the ordinary course of its business activities. Each of these matters is subject to various uncertainties, and it is possible that some of these matters may be resolved unfavorably to the Company. The Company has established accruals for matters that are probable and reasonably estimable. Management believes that any liability that may ultimately result from the resolution of these matters in excess of amounts provided will not have a material adverse effect on the financial position or results of operations of the Company. 9) Non-recurring Charge During the fourth quarter of 1999, the Company committed to a plan to dispose of its Factura kiosk business. As a result, the Company recorded a pre-tax non-recurring charge of $1,950,000 in the fourth quarter of 1999. On January 18, 2000, the Company completed the sale of certain of the assets of the Factura division to Factura Corporation, a new company partially owned by former management of the division. As a result of this transaction, the Company received cash and promissory notes in the approximate amount of $400,000 and will receive certain lease payments over a 5-year period. The Company may also receive additional payments based upon the buyer achieving certain specified revenue levels over the next five years. The non-recurring charge includes (i) $43,000 associated with personnel reductions of approximately 12 positions at the Factura division prior to the sale, (ii) $417,000 associated with estimated lease costs for the Factura facility subsequent to the sale date (net of estimated sublease income), (iii) $210,000 associated with legal and other exit costs, and (iv) $1,280,000 associated with a loss on the sale of the non-cash assets of the Factura division. No amounts had been paid as of December 31, 1999. Included in the consolidated results of operations for 1997, 1998 and 1999 are Factura sales and operating income, respectively, of $7.7 million and $80,000 in 1997, and Factura sales and operating losses, respectively, of $6.9 million and $856,000 in 1998 and $4.4 million and $1.5 million in 1999. The loss on the sale consists primarily of the writedown to fair value of certain fixed assets and goodwill. F-14 MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 10) Quarterly Results (Unaudited) Financial results by quarter for 1998 and 1999 are summarized below (in thousands, except per share amounts): 1998 ------------------------------------ First Second Third Fourth Quarter Quarter Quarter Quarter -------- -------- -------- -------- Net Sales.............................. $ 35,727 $ 37,125 $ 34,948 $ 36,570 Gross Profit........................... 13,043 14,336 13,595 14,446 (a) Net Income............................. 2,270 2,259 2,341 2,498 Diluted Earnings Per Share............. $ 0.28 $ 0.28 $ 0.30 $ 0.33 1999 ------------------------------------ First Second Third Fourth Quarter Quarter Quarter Quarter -------- -------- -------- -------- Net Sales.............................. $ 36,728 $ 41,044 $ 38,552 $ 41,167 Gross Profit........................... 13,638 14,832 13,502 11,196 Net Income (Loss)...................... (277) 2,097 2,167 (1,316) Diluted Earnings (Loss) Per Share...... $ (0.04) $ 0.30 $ 0.31 $ (0.20) - -------- (a) Certain reclassifications have been made to the quarterly 1998 consolidated statements of operations to conform to the full year 1998 presentation. F-15 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosures None. PART III Item 10. Directors and Executive Officers of the Registrant The sections entitled "Nomination and Election of Directors", "Executive Officers" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" contained in the registrant's Proxy Statement for the 2000 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission by April 30, 2000, are incorporated herein by reference. Item 11. Executive Compensation The section entitled "Executive Compensation" contained in the Proxy Statement for the 2000 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission by April 30, 2000, is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The section entitled "Security Ownership of Officers, Directors and Principal Stockholders" contained in the Proxy Statement for the 2000 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission by April 30, 2000, is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions None. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K The following documents are filed as a part of this Report: (a)(1) Index to Consolidated Financial Statements The following consolidated financial statements of MicroTouch Systems, Inc. and subsidiaries are included pursuant to Item 8: Page in Form 10K -------- Report of Independent Public Accountants............................. F-1 Consolidated Balance Sheets as of December 31, 1998 and 1999......... F-2 Consolidated Statements of Operations and Comprehensive Income for each of the three years in the period ended December 31, 1999....... F-3 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1999......................... F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1999.................................. F-5 Notes to Consolidated Financial Statements........................... F-6 II-1 (a)(2) Index to Consolidated Financial Statement Schedules The following consolidated financial statement schedules of MicroTouch Systems, Inc. and subsidiaries are included pursuant to Item 8: Schedule II Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 1999 Schedules not listed above have been omitted because they are not applicable, not required or the information required to be set forth therein is included in the consolidated financial statements or notes thereto. (b) The Company filed no current reports on Form 8-K during the quarter ended December 31, 1999. (c) Exhibits 3.1 Restated Articles of Organization, as amended to date (5) 3.2 Amended and Restated By-laws (1) 4.1 Shareholder Rights Agreement (5) 10.1 1992 Equity Incentive Plan (1) (4) 10.7 Lease Agreement between the Company and Griffin Brook Park Associates Joint Venture dated November 6, 1992 (2) 10.9 Money Market Note dated August 29, 1994 (3) 10.10 Purchase Agreement between the Company and Griffin Brook Two Associates Joint Venture dated August 2, 1995 (5) 10.11 1994 Directors Stock Option Plan (4) (5) 10.12 1995 Employee Stock Purchase Plan (4) (5) 10.13 1998 Employee and Consultant Non-Qualified Stock Option Plan (6) 10.14 Letter Agreement with Barclays Bank PLC dated April 7, 1998. (6) 10.15 Letter Agreement with Fleet National Bank dated October 20, 1999. Filed herewith. 21 Subsidiaries of the Registrant. 23 Consent of Independent Public Accountants. Filed herewith. 24 Power of Attorney (included on signature page). 27 Financial Data Schedule. Filed herewith. - -------- (1) Filed as an exhibit to a Registration Statement on Form S-1 filed on June 26, 1992 (Registration No 33-47874) and incorporated herein by reference. (2) Filed as an exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1992 and incorporated herein by reference. (3) Filed as an exhibit to Form 10-Q filed for the quarter ended September 30, 1994 and incorporated herein by reference. (4) Indicates management contracts or compensatory plans in which the executive officers or directors of the Company participate. (5) Filed as an Exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1995 and incorporated herein by reference. (6) Filed as an Exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1998 and incorporated herein by reference. II-2 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MICROTOUCH SYSTEMS, INC. /s/ D. Westervelt Davis By: _________________________________ D. Westervelt Davis President, Chief Executive Officer and Director February 28, 2000 KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Geoffrey P Clear and William T Whelan, and each of them his true and lawful attorneys-in-fact and agents, each acting alone, with full powers of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10K, including amendments, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, and hereby ratifies and confirms all his said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof. Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ James D. Logan Chairman of the Board of February 28, 2000 ______________________________________ Directors James D. Logan /s/ D. Westervelt Davis President, Chief Executive February 28, 2000 ______________________________________ Officer and Director D. Westervelt Davis /s/ Geoffrey P. Clear Vice President, Finance February 28, 2000 ______________________________________ and Administration, Chief Geoffrey P. Clear Financial Officer and Treasurer /s/ Edward J. Stewart III Director February 28, 2000 ______________________________________ Edward J. Stewart III /s/ Frank Manning Director February 28, 2000 ______________________________________ Frank Manning /s/ Peter Brumme Director February 28, 2000 ______________________________________ Peter Brumme II-3 SCHEDULE II MICROTOUCH SYSTEMS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (Amounts in thousands) Balance at Charged to Balance at Beginning Cost and Charged to Returns/ End of of Period Expense Sales Write-offs(a) Period ---------- ---------- ---------- ------------- ---------- Allowance for Doubtful Accounts and Sales Returns Year Ended December 31, 1997................... $ 3,940 $ 127 $ 1,249 $ (147) $ 5,169 Year Ended December 31, 1998................... $ 5,169 $ 529 $ 305 $ (1,048) $ 4,955 Year Ended December 31, 1999................... $ 4,955 $ 427 $ 165 $ (3,846) $ 1,701 - -------- (a) Effective January 1, 1997, the Company changed its accounting procedures to allow the value of product returns to be offset as a credit directly to sales, rather than charged against the sales return allowance. The actual value of product returns was $4.5 million, $4.9 million and $5.6 million for 1997, 1998 and 1999, respectively. EXHIBIT INDEX 3.1 Restated Articles of Organization as amended to date.(5) 3.2 Amended and Restated By-laws.(1) 4.1 Shareholder Rights Agreement.(5) 10.1 1992 Equity Incentive Plan.(1)(4) 10.5 License Agreement between the Company, Peptek, Inc and Mr. Jim Zeeger dated July 1, 1988.(1) 10.7 Lease Agreement between the Company and Griffin Brook Park Associates Joint Venture dated November 6, 1992.(2) 10.9 Money Market Note dated August 29, 1994.(3) 10.10 Purchase and Sale Agreement between the Company and Griffin Brook Two Associates Joint Venture dated August 2, 1995.(5) 10.11 1994 Directors Stock Option Plan.(4)(5) 10.12 1995 Employee Stock Purchase Plan.(4)(5) 10.13 1998 Employee and Consultant Non-Qualified Stock Option Plan.(6) 10.14 Letter Agreement with Barclays Bank PLC dated April 7, 1998.(6) 10.15 Letter Agreement with Fleet National Bank dated October 20, 1999. Filed herewith. 21 Subsidiaries of the Registrant. 23 Consent of Independent Public Accountants filed herewith. Filed herewith. 24 Power of Attorney (included on signature page). 27 Financial Data Schedule. Filed herewith. - -------- (1) Filed as an exhibit to a Registration Statement on Form S-1 filed on June 26, 1992 (Registration No. 33-47874) and incorporated herein by reference. (2) Filed as an exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1992 and incorporated herein by reference. (3) Filed as an exhibit to Form 10-Q filed for the quarter ended September 30, 1994 and incorporated herein by reference. (4) Indicates management contracts or compensatory plans in which the executive officers or directors of the Company participate. (5) Filed as an Exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1995 and incorporated herein by reference. (6) Filed as an Exhibit to the Annual Report on Form 10-K filed for the year ended December 31, 1998 and incorporated herein by reference.